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Another earnings season, and another disappointment for technology giant International Business Machines (NYSE: IBM).
The company missed analyst expectations for quarterly revenue, once again continuing a prolonged trend. IBM has now posted 14 consecutive quarters of declining revenue, a dubious distinction to say the least.
Not surprisingly, the stock has performed very poorly for an extended period. IBM is down 20% over the past two years, while the S&P 500 Index is up 15% in that time.
But while it’s easy to write off IBM entirely, there may be reasons to stick with the company and its stock through its turnaround.
IBM Earnings: Not Impressive
In the IBM earnings report, the company said it earned $3.02 per share last quarter, on $19.28 billion of revenue. On a year-over-year basis, revenue and earnings fell 13% and 12%, respectively. IBM missed analyst expectations on revenue, which called for $19.6 billion of revenue. The good news is that IBM’s earnings per share actually beat analyst expectations.
IBM managed to beat earnings expectations, but that was little consolation to investors. IBM has shed thousands of jobs and taken an axe to its cost structure. These measures have kept profits afloat, but investors understand that there is only so much a company can do to cut costs. Sooner or later, revenue needs to grow.
An optimistic perspective of IBM’s revenue is that most of the decline was due to currency. As a global, multi-national company, IBM is highly exposed to the strengthening U.S. dollar. This has weighed on its revenue growth. In fact, excluding the effects of currency fluctuations and divestments, IBM’s organic revenue was down only 1%.
Going forward, IBM suggests investors take note of the progress it is making in its turnaround. Indeed, there are reasons to not lose hope about IBM’s future. Primarily, investors should take note of the high growth achieved in its strategic imperatives.
Strategic Imperatives Lead the Way
Once again, IBM’s group of “strategic imperatives,” or what the company calls its strategic growth areas, led the way. These higher-growth segments include cloud and mobile computing, data analytics and social and security software. Overall, IBM’s strategic imperatives grew revenue by 17% last quarter. Adjusting for currency and divestitures, IBM’s strategic imperatives grew revenue by 27% year over year. Cloud revenue has now reached $9.4 billion in the trailing 12 months.
Unfortunately for the company and its investors, these businesses are still too small to lift the entire company into growth. IBM is still weighed down by a massive legacy hardware business that continues to decline. But the hope is that, over time, continued growth in the strategic imperatives will eventually make those businesses big enough to move the needle in a meaningful way.
It is not difficult to see the potential. Looking back further, growth in the strategic imperatives has been very impressive. For example, in 2009, its strategic imperatives represented just 13% of IBM’s total revenue. Last year, these businesses accounted for 27% of total revenue, more than doubling in that time. Year-to-date, revenue from the strategic imperatives is up more than 30% excluding foreign exchange and divestments.
As a result, this year, the strategic imperatives will be an even bigger part of the company, and that should continue going forward.
IBM Dividend Still Attractive
For all of its challenges, investors shouldn’t rush to judgment and sell IBM without considering its cheap valuation and compelling dividend. IBM stock trades at just 12 times earnings, which is far cheaper than the S&P 500 Index. If the company can return to growth, the stock price may enjoy a strong rally based on valuation.
And, in the meantime, investors can collect a very attractive 3.6% dividend yield. IBM still generates a lot of free cash flow – $13.6 billion in the trailing 12 months – directly a result of its strategic shift away from low-margin businesses like semiconductor manufacturing, and into its higher-value strategic initiatives.
It uses that cash to reward shareholders with rising dividends. Over the past five years, it increased its quarterly dividend by 14% compounded annually over the past five years, including an 18% raise earlier this year.
As a result, while growth investors may not see a lot to like about IBM, value and dividend investors may want to consider holding on through the company’s turnaround.
DISCLOSURE: Bob Ciura personally owns shares of International Business Machines (NYSE: IBM).
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