IBM: Transformation Beating Skeptics

| About: International Business (IBM)


IBM reported solid Q1 numbers as the company continues a transformation to analytics, cloud and mobile.

The market focuses too much on toppling numbers, missing the huge cash flow benefits to shareholders.

Ignore the skeptics and use any dips caused by the tax benefits as an opportunity to buy a stock with a high yield in the middle of a transformation.

The skeptics keep telling investors to ignore the results at IBM (NYSE:IBM) as the company is dying a slow death. Barclays even slapped a $125 target on the stock prior to earnings, suggesting the recent rally would dissipate on weak revenues.

Now the stock is trading down after hours following a big Q1 EPS beat. The media again focuses on the negatives with IBM, as the company got a $1.2 billion benefit from the previously reported $1.0 billion refund on non-U.S. taxes. The market, though, apparently wants to ignore the relative similar earnings hit from the transformational charges in Latin America that provided a nearly equal impact.

The end result is that the $2.35 earnings per share is a relatively clean number, suggesting the transformation is at the least providing stability, if not the opportunity for future growth. IBM is guiding towards a full-year EPS of at least $13.50. Based on Q1 numbers beating estimates by $0.26, the company will likely easily surpass that number, especially considering the guide up on free cash flows to the high end of guidance.

Regardless of the negativity on the stock, the company continues making the transformation with the strategic imperative categories of analytics, cloud, mobile, and security. Strategic imperatives are now 37% of total revenues, with cloud growing 36% from last year and cloud delivered as a service reaching an annual run rate of $5.4 billion.

While these transformative opportunities continue to grow at a fast clip, the legacy business has taken big hits from currency. IBM now forecasts currency becoming a tailwind for the rest of the year after taking a 2.6 point hit during Q1.

Source: IBM Q116 presentation

A shift from the currency impact on revenues will help investors focus away from the multi-year decline in revenues towards the massive free cash flows produced by IBM. For a company with a market cap of around $145 billion, the FCF is rather large at $14.2 billion last year and forecasts for around $12 billion this year.

IBM has used this cash flow to return sizable capital to shareholders over the last few years. For 2015, the company sent $9.4 billion back to shareholders via the 3.6% dividend and a large stock buyback. In total, the net payout yield (dividend yield + net stock buyback yield) is equivalent to roughly a 6.5% yield for shareholders.

IBM Chart

The yield is solid, but the above chart shows how the yield surged above 8.5% as the stock price declined to below $120. Clearly, investors got too negative, sending the stock down to these lows and any future dips will have these yield supports for shareholders.

The key investor takeaway is that the market focuses too much on the company outside a relative comparison to the valuation of the stock. IBM isn't a great company, but the company is making a solid transformation while at the same time the stock offers value. With the FCF levels and yields, the stock is attractive on all dips caused by a market focused on headline numbers and not value.

Disclosure: I am/we are long IBM.

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.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.

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