The IBM Of The Future?

| About: International Business (IBM)

Summary

IBM has a good history of returning cash to shareholders.

The company has been buying back shares for over a decade.

It has paid dividends for over 100 years, and raised them annually for more than 20.

IBM's strong cash flow will allow the company to continue these returns.

A History of Gifts

International Business Machines (NYSE:IBM) has a core tenet of shareholder returns. Its three major pillars of returns are dividends, repurchases, and reinvestment into the company's operations. The reinvestment is perhaps the most important, allowing IBM to put its cash flows to work by building the company's business segments. This creates more cash flow, which allows the company to return more cash to investors by other methods. Historically IBM has reinvested about 5-6% of revenues back into research and development to help keep the business keep growing. The company's strategic buybacks have helped IBM reduce its share count which boosts earnings per share a bit, a healthy accompaniment to organic earnings growth. And the final pillar of dividends, my favorite, is the most direct return to shareholders. This cash payment may be spent at the shareholder's discretion, to either purchase more shares or spend in other ways. And while IBM is repurchasing shares, the dividend payments will be a bit cheaper as the share count decreases. These three measures of returns work together, with each having its own importance.

Source: IBM

IBM's dividend payments have grown at an average annual rate of around 11% over the past five years. The share count has shrunken to roughly 950 million shares, (nearly half the size the company was in 2004). I've previously written a perspective on IBM's massive repurchase efforts over the years, showing some of the changes the company has gone through during that time. Also I've published a discounted cash flow model with my estimate of IBM's fair value at around $184/share. I'm going to revisit parts of the model to attempt a forecast at IBM's potential for shareholder returns during the next 10 years.

Free Cash Flow Forecast

The full discounted cash flow model has already been presented elsewhere, but parts of it will be highlighted here. The primary result to highlight is the projection of cash flows for the next 10 years obtained from adjustment of EBITDA (estimated at roughly 24% revenue margin). IBM's free cash flow will be the proxy by which dividend and repurchase capability will be measured. During 2017, IBM might be expected to pay out $5.6 billion in dividends. This is an increase of 5.6% over 2016's dividend payments. The past five years, dividend payments have grown at an average rate of 6%. For this projection, that same growth rate in annual net dividends paid will be assumed.

Revenue/EBITDA Projections

FCF Projections

Source: Author's Projections

Taking the projection a step further, it will be assumed that the remainder of the free cash flow will be entirely used for repurchases.

Share Count Reduction

While the company's dividend can keep growing, the share count will also continue shrinking. The average repurchase price will be assumed to change with revenue growth since the company's past prospects have been largely affected by growth or shrinkage of revenue. The updated share counts will help forecast the dividends paid per share.

Source: Author's Projections

The company's strategic accompaniment of dividends with repurchases maintains a decreasing share count while its dividend continues to grow.

Projected IBM FCF, Dividends, and Repurchases

Year

FCF ($Million)

Dividends ($Million)

Repurchases ($Million)

Share Price

Share Count (Million)

Div/Share ($)

FCF Payout (%)

2017E

10,592

5,618

4,974

$163.00

946

$5.94

53%

2018E

9,187

5,955

3,232

$164.17

915

$6.50

65%

2019E

9,183

6,312

2,870

$167.49

896

$7.05

69%

2020E

10,137

6,691

3,446

$173.05

879

$7.62

66%

2021E

10,534

7,093

3,441

$180.95

859

$8.26

67%

2022E

11,074

7,518

3,556

$191.34

840

$8.95

68%

2023E

12,435

7,969

4,466

$198.79

821

$9.71

64%

2024E

12,963

8,447

4,516

$207.89

799

$10.58

65%

2025E

13,597

8,954

4,643

$218.69

777

$11.52

66%

2026E

14,342

9,491

4,851

$231.25

756

$12.56

66%

Source: Author's Projections

If the share price moves roughly commensurate with the projected revenue growth, IBM would have an attractive yield accompanied by a shrinking share count. These dividend payments would be between 50 and 70% of FCF, a fairly safe payout level.

Possible IBM Dividend Yields and Growth Rates

Year

Projected Yield (%)

Yield Growth (%)

Div/share growth ($)

2017E

3.6%

2018E

4.0%

8.8%

9.5%

2019E

4.2%

6.2%

8.3%

2020E

4.4%

4.6%

8.1%

2021E

4.6%

3.7%

8.5%

2022E

4.7%

2.5%

8.4%

2023E

4.9%

4.3%

8.4%

2024E

5.1%

4.2%

9.0%

2025E

5.3%

3.6%

9.0%

2026E

5.4%

3.1%

9.0%

Source: Author's Projections

Because of the dividend/repurchase compound effect, the projected dividend/share payout is able to grow faster than the rate of net total dividend payments (6% as projected above).

Final Thoughts

IBM has a good history of returning cash to shareholders, which will continue for the foreseeable future. Share counts will be decreased while dividend payments will be able to grow. IBM's shareholder return program looks bright, and will be fueled by the company's current strong cash flows and future cash flow growth. Whether or not IBM chooses to allocate free cash flows in the above projected manner, the projection is an illustration of the company's effective mechanism of shareholder returns. The company's current yield of 3.7% and $6.00/share forward annual payout will very probably keep growing.

Compared to peers and the industry average, the company is moderately undervalued now on a P/E and EV/EBITDA basis. Additionally IBM currently trades at around $160 and a forward P/E of 13.4. I will look to add shares if the price drops under $150.

Author's Note:

I am on the lookout for high yet sustainable dividends or value opportunities with a significant margin of safety. If you're looking for the same, please hit the "Follow" button by my name at the top of the article, and hopefully you'll get some good ideas for value and income stocks.

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: I am neither a certified investment advisor nor a certified tax professional, and do not claim to be either. The data presented here is for informational purposes only and is not meant to serve as a buy or sell recommendation. Investors and potential investors should do their own research and make their own decisions. In the event that an investor or potential investor does not feel qualified to make such a buy or sell decision on their own, they should consult a certified advisor that they trust or feel comfortable with. Investing may involve losses, including potential loss of principal. The author relies on external links for some information that may have appeared on this perspective. These external links, although believed to be accurate, have not been verified independently. Therefore the author is unable to guarantee their accuracy.

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