IBM Earnings Preview Q3 FY 15: Revenue Decline To Continue?

  • IBM is due to report Q3 FY 15 earnings on Oct. 19.
  • Investors can expect IBM to report yet another quarter of falling revenues.
  • IBM's Strategic Imperatives remains a bright spot for the company.
  • Revenue from this segment might be able to offset declines in the hardware segment in 4-6 quarters.

Lumbering tech giant IBM (NYSE:IBM) is scheduled to report Q3 FY 15 earnings on Oct. 19 after closing bell. IBM said during its Q2 FY 15 earnings call that it expects to finish the third quarter with revenue roughly the same as Q1 FY 15 and ‘‘with 63% to 64% of our low end EPS guidance achieved consistent with prior years.’’ This implies that the company expects to report revenue of $19.6 billion and GAAP EPS of $2.72-$2.76.

IBM has managed to beat earnings estimate in the last three consecutive quarters. The company’s top line has, however, declined for 13 straight quarters.

Quarterly Earnings Surprise History

Fiscal
Quarter End
Date
Reported
Earnings
Per Share
Consensus
EPS* Forecast
%
Surprise
Jun2015 07/20/2015 3.84 3.8 1.05
Mar2015 04/20/2015 2.91 2.84 2.46
Dec2014 01/20/2015 5.81 5.41 7.39
Sep2014 10/20/2014 3.68 4.3 -14.42

Source: NASDAQ

Despite the beats, IBM shares have mostly been trading lower after announcing results due to its worrying revenue declines.

Company in transition

Big Blue is a company that is caught up deep in the throes of business restructuring and product cycle transitions. Some of the dramatic changes IBM has undertaken lately include selling its commodity server business to Lenovo, selling its semiconductor chip business to GlobalFoundries, and divesting its System X business. Meanwhile IBM has realigned its workforce as it continues to invest heavily in what it terms as ‘‘Strategic Imperatives’’ that consist of Cloud Business, Business Analytics, and Mobile Security.

IBM’s Strategic Imperatives remains the company’s only bright spot. IBM reported during the second quarter earnings call that the segment’s revenue was up 30%, which, the company noted was much faster than the 20% growth it posted in 2014. Although IBM stopped breaking out revenue by the segment in 2015, we can estimate its growth trajectory judging from last year’s number.

IBM finished 2014 with Strategic Imperatives revenue of $25 billion. An average growth rate of 25% for the year means that the segment is on course to realize revenue of about $31.3 billion for FY 15. While that growth is impressive, it’s unfortunately not enough to completely offset the double-digits top line decline that IBM has been recording. In fact, it would take at least another 4-6 quarters before IBM’s Strategic Imperatives comes close to completely offsetting revenue declines from its shrinking hardware business.

IBM is therefore largely a work-in-progress and investors should probably not expect much to change during the next few quarters.

FX headwinds to continue wreaking havoc on earnings

IBM is one of the companies whose earnings have lately been badly impacted by foreign exchange headwinds. During the second quarter, IBM’s top line took a huge 9% hit due to FX headwinds. Although FX headwinds have been easing somewhat for many companies, they are expected to continue negatively impacting IBM earnings and growth numbers to an appreciable degree over the coming quarters.

Is IBM worth an investment?

This is the million dollar question. Although IBM share return has been lagging the market by quite a large degree, top investors such as Warren Buffett have been gradually building their IBM position over the years. IBM’s main attraction has been its generous dividend payouts and copious share buybacks. By re-investing IBM dividends and relying on buybacks, IBM investors have been realizing pretty good gains over the years.

But the big problem now is that IBM slammed the brakes on its buybacks in 2014. Investors can no longer rely so heavily on the magic of share repurchases to grow their IBM investment. As things currently stand, IBM looks like an investment best suited for investors who are willing to hold the shares for five or more years as the company continues its transition. For short-term and medium-term investors, IBM shares remains a wildcard despite being so cheap.

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