IBM Earnings Preview: Share Repurchases Offset Weak Revenue Growth

| About: International Business (IBM)

International Business Machines (NYSE:IBM) reports their first quarter 2013 financial results after the bell on April 18th, 2013.

Per ThomsonReuters, analyst consensus is expecting $3.05 in earnings per share (EPS) on $24.688 billion in revenue, for expected year-over-year growth of 0% and 10% respectively, which is pretty consistent with IBM's results the last half of 2012.

IBM's two leading indicators - Oracle's (NASDAQ:ORCL) software business and Accenture's (NYSE:ACN) consulting business - were mixed with ORCL getting pounded after earnings in late March, while Accenture, although a little weak, has held serve since their earnings report, the last week of March.

ORCL's software business rose 4% in the February quarter, although new software license growth fell 2%. ACN's consulting business was thought to be flat, as large deals are still ramping slowly, per one report.

Sustainable cash-flow

If you are wondering if IBM will be a disaster when they report Q1 '13 financial results, don't count on it, as Big Blue's saving grace and the reason the company can generate 10% earnings growth in just about all but the most dire of economies, is their prodigious cash-flow generation, and their consistent use of this free-cash-flow to repurchase stock.

Here is our table where we track Big Blue's cash-flow, free-cash-flow and shares outstanding: note how many shares IBM has retired since the March '09 market low:

IBM's cash-flow and share repurchase history

Qtr end















12/12 $22.5 9% $18.2 10% 1,136 -4% 8%
9/12 $22.0 26% $17.6 32% 1,149 -3% 8%
6/12 $22.3 27% $18.0 34% 1,162 -5% 8%
3/12 $21.7 25% $17.7 32% 1,159 -7% 7%
12/11 $20.7 6% $16.6 5% 1,189 -4% 7%
9/11 $17.4 -3% $13.3 -8% 1,189 -7% 6%
6/11 $17.5 -6% $13.4 -12% 1,221 -4% 6%
3/11 $17.3 -12% $13.3 -18%


-5% 7%
12/10 $19.5 -6% $15.8 -8% 1,240 -8% 9%
9/10 $18.0 -12% $14.5 -13% 1,273 -5% 8%
6/10 $18.5 -6% $15.3 -4% 1,279 9%
3/10 $19.7 2% $16.3 6% 1,301
12/09 $20.9 10% $17.3 18% 1,341
9/09 $20.2 12% $16.6 20%


6/09 $19.8 13% $16 22%
3/09 $19.3 bl 15% $15.3 bl 25%

Source: internal spreadsheet, earnings reports, 10-Q's, 10-K's

TTM - trailing twelve-month

CFO - cash-flow from operations

FCF - free-cash-flow (traditionally defined as cash flow less capex)

FCF yield - TTM free-cash-flow divided by market cap

IBM's numbers are impressive in that "capex' is just 20% of cash-flow and thus free-cash-flow is 80% of cash-flow. Big Blue generates a lot of surplus greenbacks, which IBM uses to make small acquisitions, pay dividends and repurchase more shares.

Per our internal spreadsheet, IBM returns capital to shareholders in the ratio of 25% dividends and 75% share repurchases. Put another way, the dividend amounts to about $1 billion per quarter, and the share repurchase allocation amount to $2 - $3 billion per quarter.

The key metric in the above table is the free-cash-flow yield (FCF yield) which basically tells an investor the amount of IBM's market cap that could be retired by the current free-cash-flow generation. As the reader can quickly see, IBM's free-cash-flow yield is consistently 7% - 9%, which is impressive, and a nice cushion.

Another way to look at this is to ask, without the share repurchase program, what would IBM's annual EPS have been in 2012 assuming no shares were repurchased:

2012 IBM actual EPS = $15.25 per share

2012 net income = $17.627 billion

shares outstanding 12/31/11 = 1,188.7

shares outstanding 12/31/12 = 1,136.0

EPS for 2012 assuming 1,188.7 shares outstanding: $14.82 per share

The difference: $0.43 per share or 3% of the actual ending EPS value.

While that may not seem like a lot of dollars, add 3% to a company's stock price every year, with little-to-no operational risk, and you begin to see how this adds up over time. Or again, another way to think about it, is that without any growth in revenue or any productivity savings on the expense line, IBM can automatically count on 3% - 5% EPS growth per year simply from share repurchases.

That is a nice safety net.

Revenue growth would be nice:

When IBM reports on April 18th, I think investors will see low-to-mid single digit revenue growth, depending on currency, and double-digit EPS growth.

IBM's stock has been consolidating since the mid-October '12 high of $212. It broke out in January and February '13, only to fall back to this trading range. EPS revisions have been positive over the last year, even though revenue estimate revisions have been negative, again likely due to the share repurchase program.

Our internal model values IBM at $232 per share, while Morningstar has an "intrinsic value" on IBM of $208. We'd be a strong buyer of IBM near the Nov '12 lows of $180 up to $190.

The lack of revenue growth is somewhat worrisome, which I suspect is indicative of all large-cap global players today. Analyst consensus per ThomsonReuters is expecting 0% revenue growth in 2013 and then just 4% and 3% through 2015.

The next big upward move in the stock price may only come when revenue growth moves consistently into the mid-to-high single digit growth range. But for now, take comfort in the share repurchase "safety net" and the prodigious cash-flow generation. This means IBM can grow and add to EPS when other companies can't.

Disclosure: I am long IBM, ORCL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.