IBM: Fighting Seasonal Headwinds Now

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About: International Business Machines Corporation (IBM)
by: Stone Fox Capital
Summary

IBM dipped after the market was disappointed with Q1'18 constant currency revenues.

The stock traditionally drops after the first earnings report of the year suggesting a seasonal headwind that will disappear.

A 4% dividend yield limits the downside risk at $150.

International Business Machines (IBM) is taking another hit as the company faces a traditional Q1 headwind as the market isn't happy with currency tailwinds. The better investment option is to focus on the continual progress made on strategic imperatives that is leading to consistent strong cash flows and large capital returns.

Source: IBM

Revenue Problems

For years, the market fretted over IBM consistently reporting revenue declines that the return to growth in Q4'17 was reason to celebrate. The big revenue growth reported with Q1 results though came with a major hiccup.

IBM reported revenues of $19.1 billion for shockingly positive revenue growth of 5.1%. On a headline basis, the numbers are impressive and worthy of a huge rally in the stock. The stock though ended down over $12 on the first day following earnings as these revenue gains were all due to currency.

Removing the currency tailwind, revenues only grew fractionally to $18.2 billion and scrapped away the $900 million in actual reported gains. Naturally, the market wants to see revenue growth on a constant currency basis.

Source: IBM Q1'18 presentation

The crucial growth in strategic imperatives was down to only 10% when using constant currency rates. The market might have some initial disappointments over this growth rate dipping, but the reported numbers were around 15% growth with cloud showing impressive 20% growth.

More importantly, strategic imperatives is now 47% of Q1 revenues, up from only 43% in the prior-year period. The As-a-service annual exit rate reached $10.7 billion, up from $10.3 billion in Q4. The constant currency growth rate jumped 200 basis points to 20%. The ability to consistently shift to enterprise could, AI and security business lines is a big part of the long-term thesis of not worrying about legacy revenue declines and the associated hits to the top line.

The headwind appears more a seasonal one with the stock trading down after every Q1 earnings report for the last 10 years. Bespoke research outlines this historical headwind going back to 2009 that includes some rather large declines.

Part of the seasonal headwind comes from the strategic imperatives hitting a low during the traditional weak Q1. This growth category was 49.3% of revenues during Q4 so the expectation is for IBM to cross the 50% threshold this year for the strategic imperative category. Such a move will no doubt be a major catalyst for the stock and another reason that buying the $12 dip is the ideal play here.

More Important Story

The market gets lost on the revenue story on a regular basis. The 5% growth rate due to currency actually backs up the plans outlined by IBM for high single-digit EPS growth going forward. The further strength in strategic imperatives is another reason to get behind this previous forecast.

The company maintained 2018 EPS estimates at $13.80 or above. The recent investor briefing forecast the EPS jumping by a dollar per share each year starting with 2019. Such a scenario is very favorable for the stock trading with a 4% dividend yield and at around 10x forward EPS guidance of the company.

The important story is that when the dividend yield dips to 4%, IBM has been a buy over the last 3 years. The market regularly gets too negative, but the yield support limits the risk of owning the stock on dips.

Chart
IBM data by YCharts

Takeaway

The key investor takeaway is that IBM has gone from fighting currency headwinds that hurt revenues for years to seasonal stock headwinds where currency tailwinds are ignored by the market. Either way, the stock traditionally becomes a bargain and rebounds when the dividend yield reaches 4%.

Below $150, IBM offers another dip opportunity as the seasonal clouds will part for the stronger strategic imperative quarters later this year and the eventual cross of the 50% revenue threshold. Buy the dip with forward EPS approaching a 10x P/E multiple.

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.