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IBM (IBM) Up 4.8% Since Last Earnings Report: Can It Continue?

Zacks Equity Research

It has been about a month since the last earnings report for IBM (IBM). Shares have added about 4.8% in that time frame, outperforming the S&P 500.

Will the recent positive trend continue leading up to its next earnings release, or is IBM due for a pullback? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at the most recent earnings report in order to get a better handle on the important catalysts.

IBM's Q4 Earnings Top Estimates, Cloud Momentum Drove Top-Line Growth

International Business Machines Corporation reported fourth-quarter 2019 non-GAAP earnings of $4.71 per share, which surpassed the Zacks Consensus Estimate by 0.4%. However, the bottom line fell 3% on a year-over-year basis.

Revenues of $21.78 billion surpassed the Zacks Consensus Estimate by 0.4% and inched up 0.1% on a year-over-year basis. At constant currency (cc), the top line improved 1%. Adjusting for currency and divested businesses, the top line increased 3%.

The year-over-year revenue growth can primarily be attributed to increase in Cloud & Cognitive Software Segment and Systems revenues. Markedly, total Cloud revenues came in at $6.8 billion during the quarter, up 21% year on year.

However, revenues from signings declined 9% (at cc) in the fourth quarter to $14.4 billion. Also, backlog fell 3% (at cc) year over year and amounted to $112.4 billion.

Red Hat Acquisition

IBM completed the acquisition of Red Hat on Jul 9, 2019, for $34 billion in cash. The deal is in sync with the company’s efforts to bolster Open Hybrid Architecture Initiative. Red Hat is part of the Cloud and Cognitive Software segment.

Revenues from Red Hat in the fourth quarter rallied 24% (at cc) on a normalized basis. Infrastructure for Red Hat continued to grow in double-digits. Moreover, OpenShift and Ansible has supported advancements in application and technology developments.

Further, the acquisition has helped leveraging IBM containerized software and accelerate service engagement. Currently, more than 2,000 clients are using Red Hat and IBM’s hybrid cloud platform.

Geographic Revenue Details

Revenues from Americas increased 6% (excluding divestiture impacts) and came in at $10.5 billion. Revenues from Europe, Middle-East and Africa were $7.1 billion, up 4% year over year. Meanwhile, revenues from Asia-Pacific declined 6% on a year-over-year basis and came in at $4.2 billion.

Cloud & Cognitive Software Segment

The Cloud & Cognitive Software segment’s revenues-external rose 8.7% year over year (up 9.4% on cc basis) to $7.2 billion. The upside can be attributed to growth in cloud, security and IoT solutions. Markedly, cloud revenues surged 75%.

Further, revenues in the Cloud and Data platforms increased 19% year over year. The platform is gaining from Red Hat’s acquisition synergies and traction in Cloud Paks suite.

Revenues in the Cognitive Applications inched up 1% year over year, driven by AI led software solutions in areas such as security and IoT.

Revenues in the Transaction Processing Software, which includes software that runs mission-critical workloads, moved up 3% on a year-over-year basis.

Global Business Services Segment

Revenues in the Global Business Services-external segment totaled $4.2 billion, which declined 0.6% (down 0.3% at cc) from the year-ago quarter’s figure.

Consulting revenues increased 4% year over year on solid performance of IBM’s digital business. Application Management and Global Process Services revenues declined 3% and 10% (at cc) year over year, respectively.

Global Technology Services Segment

Revenues from Technology Services-external fell 4.8% (down 4% at cc) from the year-ago quarter’s level to $6.9 billion. The downside was caused by lower client business volumes.

Segmental revenues pertaining to cloud advanced 13% from the prior-year quarter’s reported figure.

Infrastructure & Cloud Services and Technical Support Services revenues fell 5% and 2% (at cc) year on year, respectively.

Systems Revenues

Systems revenues rose 16% (up 16.5% at cc) on a year-over-year basis to $3 billion, primarily owing to growth in the IBM Z and Storage Systems.

Further, Operating Systems Software and Systems Hardware revenues increased 8% and 18% (at cc) year over year, respectively.

IBM Z revenues surged 63% year over year owing to gains from z15 as well as higher demands for data privacy and resiliency solutions across hybrid cloud. However, Power revenues fell 23% from the year-ago quarter’s tally.

Storage revenues improved 3% year over year owing to growth in high-end storage systems.

Finally, Global Financing (includes financing and used equipment sales) revenues dropped 25.3% year over year and 24.9% at cc to $301 million. The decline was caused by closure of OEM commercial financing operations.

Operating Details

Non-GAAP gross margin came in at 51.8%, up 230 basis points (bps) year on year. The gross margin benefited from high-value software and systems contributions.

Non-GAAP operating expenses (research & development expenses and selling, general and administration expenses) increased 12.9% year over year. On a GAAP basis, the metric increased 16%.

Pre-tax income margin from continuing operations contracted 150 bps on a year-over-year basis to 21.6%.

Balance Sheet & Cash Flow Details

IBM ended fourth-quarter 2019 with $9 billion in total cash and marketable securities compared with $10.82 billion in the previous quarter. Total debt (which includes $24.7 billion from Global Financing debt) was $62.9 billion, down $3.4 million from the last reported quarter. Moreover, since the closing of the Red Hat acquisition, the company was successful at reducing debt by 10 billion.

The company reported cash flow from operations of $3.5 billion and generated free cash flow of $6 billion in the quarter under review.

Moreover, the company returned $1.4 billion to shareholders through dividends.

Guidance

For 2020, IBM expects non-GAAP earnings per share to be at least $13.35.

Further, IBM anticipates 2020 free cash flow of $12.5 billion.

How Have Estimates Been Moving Since Then?

It turns out, estimates revision have trended downward during the past month. The consensus estimate has shifted -8.08% due to these changes.

VGM Scores

Currently, IBM has a subpar Growth Score of D, a grade with the same score on the momentum front. However, the stock was allocated a grade of A on the value side, putting it in the top 20% for this investment strategy.

Overall, the stock has an aggregate VGM Score of B. If you aren't focused on one strategy, this score is the one you should be interested in.

Outlook

Estimates have been broadly trending downward for the stock, and the magnitude of these revisions indicates a downward shift. Notably, IBM has a Zacks Rank #2 (Buy). We expect an above average return from the stock in the next few months.



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