IBM (NYSE:IBM) reports 4th quarter 2013 financial results after the closing bell on Tuesday, January 21, 2014.
The stock is now what only can be described as a huge "battleground" Dow 30 component as very divergent opinions are heard about the shares, and the opposing views are binary: the stock is going to wind up at either $160 or $220, depending on who you listen to.
Analyst consensus around Tuesday night's expectations are for $5.99 in earnings per share (EPS) on $28.254 billion in revenue, for expected y/y growth of +11% and -4%, respectively. If consensus Q4 2013 numbers are met, IBM would have grown EPS and revenues in full-year 2013 by 11% and -4% respectively as well.
The Q3 2013 earnings report was a bit of a mess: revenues were flat y/y and missed expectations by $1 bl on 10% EPS growth aided by a lower-than-expected tax rate, so the quality of the EPS growth was low. IBM's effective tax rate for Q3 2013 was 16% versus 24% the prior quarter. Per our math the lower tax rate accounted for $350 - $400 million in additional operating income, or $0.35 to $0.40 in low-quality EPS. Emerging markets were a disaster with BRIC revenues down 15% and China down 22%. (HPQ had a similar issue in China and Meg Whitman replaced the regional CEO immediately. Not sure if IBM did the same.)
We maintain a small position in IBM, and the reward will be great if Big Blue puts up a home run quarter and the stock jumps back into the mid $190s.
However, here is our biggest misgiving around the stock: the consensus revenue estimates continue to decline unabated, and it makes me more than a little nervous:
|Month / Qtr|
* Consensus revenue source: ThomsonReuters
* rev cons = revenue consensus per Thomson
The reason we picked the month and year periods was to give readers the consensus estimate after Big Blue had reported quarterly earnings and after the revisions in analyst estimates had taken place.
As the reader can see, the 2014 and 2015 consensus revenue estimates have been getting slashed pretty routinely over the course of 18 months.
Everyone knows that IBM is a prodigious cash-flow generator producing about $20 bl in cash-flow per year pretty consistently, about 2/3rds of which becomes free-cash-flow and is then spent on share repurchases, which then helps support EPS growth.
However I think IBM ultimately needs to drive revenue growth to support cash-flow and the generous return of capital.
Big Blue is supposedly continuing to offer their low-end server business for sale, and to push the former mainframe giant into the cloud and hybrid cloud segments of technology.
The challenge to IBM currently is the challenge faced by many technology companies: the willingness and ability to shift and change a company's business model to adapt to technology life cycles that in many cases may only be 5 - 10 years in length from inception to maturity.
On the bright side, although this earnings preview may sound very dire, Accenture's and Oracle's November quarter end results reported in late December are both thought to be leading indicators for IBM's consulting and software businesses and both reported better-than-expected numbers.
IBM is in a transformational period, and this is no easy call. We retain a small position in Big Blue, and frankly I believe in Ginni Rometty and her ability to right the ship and capitalize on emerging tech trends.
Technically, IBM held the low $170s in both October and December '13, and held the 50-week moving average on the charts. Given the technicals, it is tempting to add to the shares in small lots in larger client accounts without making a big bet on the position.
Fundamentally, analyst consensus per above is expecting just 1% - 2% revenue growth the next 3 years, which is then expected to generate high single-digit to low-double-digit EPS growth from 2014 through 2016.
Using our earnings-based model, our intrinsic value model values IBM at $215 per share, while Morningstar's intrinsic valuation model values IBM at $208 per share. Taking an average of $211 - $212, IBM is currently trading at a discount to perceived intrinsic value of 10%.
A trade back to the low $170s puts IBM at a discount to intrinsic value of 18%.
IBM's valuation, cash-flow and technicals are somewhat appealing. The revenue estimate decline is not.
To be frank, in Big Blue's case, I would rather be a little bit late to add more shares and see how the quarter shakes out and how the forward estimates shake out than eat a 10% drop while the stock is still range-bound.
Technically, one more trade down to the mid to low $170s area would likely entice me to add to our position.
The 2014 EPS estimate must stop falling too.
We have less than a 1% position in IBM in client accounts per this writing, where we had a 5% position at the end of 2012, start of 2013.
Thanks for reading.