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Summary

  • Big Blue has improved technically.
  • Accenture and Oracle leading indicators for IBM's consulting and software biz.
  • Forward guidance will be paramount.

So far, 14 weeks into 2014, it is clear the stock robust market of 2013 is not going to continue and the early themes for this year are that 2013's winners are now laggards, and Commodity and Value stocks are outperforming the rest of the market.

IBM (NYSE:IBM) was most definitely a 2013 laggard, still down about 5% in its rolling 1-year return and down 2% (excluding the dividend) in calendar 2013.

Year-to-date in 2014, IBM is +4%, fitting with the above theme that 2013's laggards have now become 2014's winners.

When IBM reports after the bell on Wednesday, April 16th, analyst consensus as they currently project are expecting $2.54 in earnings per share (NYSEARCA:EPS) on $22.91 billion in revenues, for expected year-over-year (y/y) declines of 15% and 2% respectively.

Everyone is familiar with IBM's story of using cash-flow and free-cash-flow (of which they have generated quite a bit), to grow EPS through share repurchases, even as top-line growth and operating income have remained less robust.

The problem is, without some mid to high-single-digit (HSD) revenue growth eventually, there is only so much room you can squeeze out of the middle of the income statement and the balance sheet in terms of cash-flow.

Growth and specifically revenue growth is what is needed for IBM.

Two companies that are long thought to be leading indicators for IBM since their quarter-end comes a month before IBM's are Accenture (NYSE:ACN) and Oracle (NYSE:ORCL), given ACN's global consulting business and Oracle's software business.

ACN fell $6 or almost 10% following their March '14 earnings release, and the stock has stayed down, while ORCL also fell post their earnings release, but the stock has rallied back to the $40 level since.

IBM by Segment:

Global Business and Technology Services (together) is expected to report roughly $13 billion of revenue and represents roughly 60% of IBM's revenue. The two segments are expected to be flat y/y versus the 3% - 4% declines from q1 '13, so there is some improvement expected in Big Blue's largest segments;

Software: roughly 25% of IBM's revenue, software is expected to grow 4% - 5% year-over-year, with quarterly revenues estimated $5.8 billion. Given ORCL's tepid results, I don't know that too many analysts are expecting robust results out of Software. There have been a few analysts come out and say IBM's Cloud Strategy is a non-starter, which I do not have an opinion on. For my money, given IBM's size and installed base, if they want into a particular hardware or software segment, they will eventually get it right, and figure it out;

Hardware: Consensus is expecting roughly $2.5 bl in revenues for Big Blue's Hardware division, with a drop in q1 '14 of 17% - 18% versus last year's q1 '13 17% decline. Hardware is 10% - 11% of IBM's revenues, but I'm not sure if this includes or excludes the x86 sale to Lenovo (OTCPK:LNVGF). IBM is looking to exit some of their low-end hardware businesses. Presumably the Street will be updated on the call;

Revenue growth:

3/31/201312/31/20139/30/20136/30/20133/31/201312/31/20129/30/20126/30/20123/31/201212/31/2011
Revenue - actual$0$27,699$23,720$24,924$23,408$29,304$24,747$25,784$24,673$29,487
F/C revenue estimate$22,938$28,254$24,770$25,394$24,620$29,087$25,363$26,275$24,777$29,700
Upside (downside) surprise -2%-4%-2%-5%1%-2%-2%0%-1%

Here is a table from our internal spreadsheet that shows IBM's "actual vs. estimate" on quarterly revenues: in the 8 quarters including 12/31/11 or the last two years, IBM has only reported one upside surprise and that was in December, 2012.

Yoy. Growth rate3/31/201312/31/20139/30/20136/30/20133/31/201312/31/20129/30/20126/30/20123/31/201212/31/2011
* Hardware
* Global Services
* Software
* Global Financing
* Enterprise Invst. / Other
Total revenues-2%-5%0%-2%-5%-1%-5%-3%0%2%

Source: internal spreadsheet (both tables)

Here is another table from our internal spreadsheet that shows IBM's y/y revenue growth for the last 10 quarters, the best y/y growth IBM could muster is 0%. 9 of the 10 quarters have seen y/y revenue declines for Big Blue.

However IBM's story has always been about free-cash-flow (FCF) and returning that FCF to shareholders in the form of share repurchases, which has allowed Big Blue to grow EPS at a far faster rate than revenues the last 3 years.

Here is our IBM Statement of Cash-Flows which we've configured to fit our analysis and give us greater insight into how Big Blue returns FCF to shareholders:

Cash from operations (ex fin recvble)$5,564$3,279$4,435$2,425$10,497$4,187$4,942$2,867$10,024$4,471$4,313$1,856
Capital expenditures($1,000)($1,041)($1,964)($729)($981)($1,046)($1,278)($1,002)($1,059)($991)($952)($1,058)
Dividends$0$0$0$0$0$0$0$0$0$0$0$0
Free-cash-flow$4,564$2,238$2,471$1,696$9,516$3,141$3,664$1,865$8,965$3,480$3,361$798

CFO as % of net income

90%81%137%119%180%101%127%140%183%116%118%132%
FCF as % of net income74%55%77%50%163%76%94%61%163%91%92%28%

4q trailing CFO

$15,703$20,636$21,544$22,051$22,493$22,020$22,304$21,675$20,664$17,436$17,516$17,304
4q trailing CFO - growth rate-30%-6%-3%2%9%26%27%25%6%-3%-6%-12%
4q trailing FCF$10,969$15,921$16,824$18,017$18,186$17,635$17,974$17,671$16,604$13,332$13,396$13,343
4q trailing FCF - growth rate-40%-10%-6%2%10%32%34%32%5%-8%-12%-18%
4q trailing capex$4,734$4,715$4,720$4,034$4,307$4,385$4,330$4,004$4,060$4,104$4,120$3,961
y/y growth10%8%9%1%6%7%5%1%10%19%24%17%
capex as % of revenues5%5%5%4%4%4%4%4%4%4%4%4%
capex as % of cash-flow30%23%22%18%19%20%19%18%20%24%24%23%
Free-cash as % of revenues
Free-cash as % of market cap6%8%8%9%8%8%8%7%7%6%6%7%
4q trailing CFO per share$14.54$18.92$19.57$19.80$19.80$19.16$19.19$18.70$17.38$14.67$14.34$13.95
price to CFO p/s13910101010101111131312
4q trailing FCF per share$10.16$14.59$15.28$16.18$16.01$15.34$15.47$15.25$13.97$11.22$10.97$10.76
price to FCF p/s
quarterly dividend$1,037$1,037$978$948$943$943$943$943$868$868$868$868
quarterly share repo$5,800$1,917$2,987$2,593$2,999$2,999$2,999$2,999$3,761$3,761$3,761$3,761
quarterly capital returned$6,837$2,954$3,965$3,541$3,942$3,942$3,942$3,942$4,629$4,629$4,629$4,629
4q trail dividend$4,000$3,906$3,812$3,777$3,772$3,697$3,622$3,547$3,472
4q trail share repo$13,297$10,496$11,578$11,590$11,996$12,758$13,520$14,282$15,044
4q trail capital returned$17,297$14,402$15,390$15,367$15,768$16,455$17,142$17,829$18,516
Capital returned as % of FCF158%90%91%85%87%93%95%101%112%

Source: internal spreadsheet

There are two red flags about the numbers that give us pause:

1.) cash-flow coverage of net income has fallen below 1(x) for the quarter cash-flow versus quarterly net income;

2.) IBM is returning more than 150% of their free-cash-flow to shareholders, with the difference seemingly coming from long-term debt issuance. In and of itself both these metrics aren't incredibly worrisome, but the lack of revenue growth at IBM, could be forcing the Chief Financial Officer to stretch a little bit to preserve the buybacks, hoping that future growth restores the balance at IBM.

Long-term debt has risen at Big Blue from $22 billion as of June 30, 2011 to $32 billion as of 12/31/13.

Big Blue's debt-to-capital ratio has risen from 19% - 20% to 26% as of 12/31/13.

Again, none of this is alarming, but I notice it.

Summary / conclusion: the revenue estimates continue to show downward revisions for Bib Blue, which is a table or spreadsheet we didn't show, but the 2014 and 2015 EPS estimates have started to stabilize, which is a good sign.

No question IBM needs to reinvigorate revenue growth which would aid margins and grow cash-flow as opposed to financial engineering which is keeping EPS stable to growing while the business is re-engineered to areas like the Cloud, etc. I do think IBM is a "return-to-global growth" play which means that once enterprise businesses start spending again, the large global tech plays will participate.

I do think IBM's Global Technology and Business Services mints cash. (But again, it was 2011 when these segments saw mid-single-digit revenue growth, versus the low-single digit revenue growth expected today and for the next few years.)

We currently have a 1.6% position in IBM within client accounts, have added to the stock since the fall of 2013. We are planning to add to the stock if the price falls below $190 in the next quarter, and we'd add even more if the stock traded down to its converging 50 and 200 day moving averages near $185 - $186.

We wrote about the q4 '13 IBM earnings report here where we were also concerned about revenue growth as well. The difference today is that the stock has gotten rid of some mo-mo investors and has been building a long base between $173 and $200 per share.

Here is another article we wrote about IBM in October, '13 as a fallen market leader.

IBM is starting to reassert its leadership, but fundamentals must follow the technical improvement.

We like IBM much better between $185 - $190, but a lot will depend on what IBM management says on the call about 2014 EPS and revenue guidance.

Current Street consensus is expecting (for calendar 2014) full-year EPS of $17.85 on revenues of $99.3 billion for expected full-year growth of 10% in EPS on a -0.5% revenue decline.

If new IBM CEO Ginny Rometty wants to put her stamp on Big Blue, now is her chance. She was dealt a tough set of cards, with the hardware business declining, and a global slowdown.

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.

Source: IBM Earnings Preview: Technically Better, Still Worried About Revenue Growth

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