- IBM is scheduled to release its Q3 results on Monday, 17th October, after the market close.
- The company has been in a turnaround mode. Watch out for growth in strategic imperative business.
- Analysts' expect IBM to report a decline in revenues and earnings.
Once the darling of Wall Street, International Business Machines Corp. (NYSE:IBM) is currently a no-go for many analysts. Big Blue has reported consistent revenue decline year after year for the last five years. IBM stock performance in past few years has been dismal. The stock has also been a drag on Warren Buffett's portfolio. But things are changing this year, for the better. IBM has been in a turnaround mode for last few years, dropping some of its traditional businesses and entering some of other fast growing businesses. The last quarter results showed that some of IBM's bets are beginning to pay off. And while the revenue continues to decline, the rate of decline is slowing down.
Can Strategic Imperatives Continue Its Strong Performance?
As the name suggests, this is IBM's biggest strategic investment. This is a fast growing segment consisting of big data and business analytics, cloud computing, and engagement. IBM has made huge investments in this segment, both in terms of money and in terms of management time. In the first six months of this year alone, the company acquired 12 companies for around $5 billion, nearly all of them are related to its strategic imperatives business. And these efforts have started to show some results.
In Q2, the revenue from this segment grew 12% YoY to $8.3 billion, led by the cloud division. Cloud grew by 30% YoY in the quarter, contributing $3.4 billion in revenues. This segment will need to keep up its revenue growth to offset the decline in IBM's traditional businesses. IBM expects this segment to contribute $40 billion in revenues by the end of 2018. In the last 12 months, strategic imperatives have contributed $30 billion in revenues. So at this rate, the company can definitely beat its expectations. A lot of post-earnings movement in the stock price will be dependent upon the performance of this segment.
Apart from the cloud, another growth driver for IBM is its analytics business and the Watson platform. In Q2, Analytics division contributed $4.7 billion in revenues, up 5% YoY. Over the last two-quarters, it has brought in $9.1 billion in revenues. It is the biggest bet in the strategic imperatives segment. IBM has been investing heavily in analytics and cloud datacenters over the past year. This segment can be a clear differentiator and also a long term growth driver. Watson has made a breakthrough in several fields, including healthcare, education, cybersecurity and weather forecasting. IBM has entered into a partnership with the New York Genome Center to identify promising personalized treatments for cancer patients. This segment has huge opportunities. To quote Martin Schroeter from Q2 earnings call:
"Healthcare organizations such as the U.K.’s National Health Service, the U.S. Department of Veterans Affairs, and the American Diabetes Association were among many in the quarter that announced they are leveraging Watson to create new approaches to treatment and patient care."
Numbers To Watch Out For
Analysts' expect IBM's revenue and earnings to continue the declining trend, though the decline is expected to be lower than the previous quarter. Analysts' expect IBM to report earnings of $3.24 on revenue of $19 billion. The estimates represent a 3% YoY decline in earnings and a 1.5% YoY revenue decline (compared to 3% in the previous quarter). Strategic imperatives will be the key driver in the coming earnings.
IBM has delivered an earnings beat in all the last four quarters. In the previous quarter, IBM reported earnings of $2.95 on revenue of $20.7 billion. While the strategic imperatives segment showed strong growth, the revenue from hardware was down 28% while software revenues were down 4%. The revenues from these segments will continue to decline in the current quarter.
IBM stock has handsomely beaten the market delivering more than 10% return this year. And apart from the capital appreciation, IBM offers a very attractive yield of 3.63% compared to 2% of S&P 500. It is one of the reasons why the Oracle of Omaha, Warren Buffett, likes IBM stock. IBM also has a good profit margin and high return on equity. Its roe (ttm) stood at an astounding 80%. But this was largely because of leverage. IBM's debt to equity ratio stands at 2.8 which is a concern.
But IBM stock is losing its momentum going into the earnings, breaching its 100 day SMA support line. The decline in price is mostly because of negative analysts sentiment. But a strong performance, especially from the strategic imperative business could act as a tailwind for the stock. The company has reported seventeen consecutive quarters of revenue decline. IBM stock currently has a consensus hold rating from analysts.