Summary
IBM (NYSE:IBM), the stock everyone loves to hate. Over the last five years, the company has been in a slow and steady decline, suffering from 16 consecutive quarters of revenue decline. Nearly every major segment of the company has been in decline due to the emergence of cloud technology and the decline of IBM's legacy software and hardware businesses. Faced with these headwinds, the company has been slowly transforming itself, shedding assets and laying off workers in declining segments while investing and adding employees in new and emerging technologies.
It's been a rough few years…
After five years of declining revenue many investors have throw in the towel. There is only so much that people can take. The company has disappointed time and time again, propping up earnings through buybacks while promising to turn things around only to miss in the next quarter. Meanwhile, investors who have held onto the stock have underperformed to S&P 500.
I get it, the charts ugly, the stock price, earnings and revenue are all down and investors have heard what seems like the same thing over and over again.
But there's just one thing I want to point out. Despite all of this decline and underperformance, IBM is STILL massively profitable. Call it manipulation, call it what you want, but throughout all of these bad years the company has still managed to return billions to shareholders through dividends and buybacks while investing money in new technology and initiatives.
So, despite the declines, investors who are purchasing the stock now are not just buying a lottery ticket hoping the company recovers from near bankruptcy. Investors still get a profitable company expected to bring in over $12B in free cash flow and earn at least $13.50 a share this year.
But the turn around is almost here…
One of the major knocks on the company is that their new initiatives (Cloud, Data Analytics) are not growing fast enough to make a large impact on earnings. However, the new initiatives are making progress and are at the point where they are finally making up meaningful portion of revenue.
During mid-April, the company reported earnings for the first quarter and it showed that progress is being made. While revenue declined overall the company showed strong growth in strategic imperatives where it has invested $30B since 2010. The company reported revenue in strategic imperatives of $7B for the quarter, an increase of 14% year over year and making up nearly 37% of total revenue for the quarter.
Breaking down the segments it becomes clearer that the company is getting closer to turning the corner. Strategic imperatives are spread out through three of the companies segments: Cognitive Solutions, Global Business Services and Technology Services & Cloud Platforms. These three segments only had declining revenue of 1.7%, 4.3% and 1.5% respectively. Compared to their previous results, this is pretty good and means that the new investments are beginning to have an impact on earnings. The primary revenue decline seems to have come from Systems and Global Financing, which were down 21.8% and 11.2% respectively. Neither of these segments are part of the new investments the company is making so naturally, they will be in more significant decline than the other segments. This shouldn't come as a surprise to investors as the global hardware business has been in decline for some time now.
Still returning cash to shareholders:
As mentioned in the beginning of the article, IBM has already returned billions of cash to shareholders through dividends and buybacks. During 2015 alone, the company returned $9.5B in cash to shareholders, $5B in dividends and $4.5B in share buybacks.
For the rest of 2016, the company still has $4.7B left in its current buyback authorization. Additionally, the company recently raised its quarterly dividend by 7.7% to $1.40. This reiterates that while the company is turning the corner, they are still returning cash to shareholders.
Finally, it's not like the payout ratio is very high. Throughout these past few years, the payout ratio has been rising but is still at a very manageable level. The current TTM payout ratio is less than 40% and if the company meets its current 2016 earnings guidance, the full year payout ratio will only rise to 41%. This will leave the company with lots of flexibility to continue repurchasing shares and investing in its strategic imperatives.
Conclusion
IBM certainly faces many challenges in the near-term. However, the company was so large before that repositioning itself is not an easy thing. These things take time. It is understandable that investors run away when times are tough but it can also be one of the best times to get in. Investors purchasing the company now will get a nearly 4% yield on a stock trading at 9x forward earnings. Additionally, the payout ratio is only 40% leaving them with plenty of flexibility to continue investing in their strategic imperatives as well as continue returning cash to shareholders. As these investments in the strategic imperatives begin to turn profitable, the company will finally see the benefits of the past few years of transition. Instead of just focusing on the companies past struggles, investors should focus on the future earnings potential for the company as this will allow them buy ahead of the coming wave. The time to buy a stock is not when it is a street favorite; the time to buy is when the stock is hated, once everyone has thrown in the towel and given up. What do you think?
