IBM Under Heavy Accumulation Since December
Summary
- The Red Hat acquisition and a new innovation-focused CEO may lead to a strong period ahead for the stock.
- Growth in cloud sales, AI development and blockchain technologies may drive IBM's business fortunes in the next decade.
- Heavy investor accumulation trends are apparent in the momentum indicators I have followed closely over the last five months.
I want to start by saying I really don’t like the excessive debt carried by International Business Machines (NYSE:IBM). If this was the only variable in picking a winner or loser, IBM would be a slam-dunk bearish choice. $65 billion in debt, $133 billion in total liabilities and a negative -$52 billion in tangible book value at the end of March are a lot to swallow. However, that’s not how stock picking works. Successful investors need a complete picture, a list of the pros and cons. Hardly ever does an investment in an individual company fit all the parameters of the perfect bull argument you might dream up. And often, the sure-fire success stories can easily reverse into underperformance.
But here’s my bullish argument. IBM is undeniably under heavy accumulation. Maybe renewed investor interest is flowing from the newly installed CEO Arvind Krishna or his $34 billion lead effort to purchase Red Hat in 2018-19 is starting to bear fruit. He has been an innovation-focused manager, building and expanding new markets for IBM in artificial intelligence, cloud, quantum computing, and blockchain. Maybe some large hedge funds are looking at the relative safety of IBM’s business in past recessions as a place to hide during the coronavirus pandemic. Maybe investors en masse are gravitating toward the company’s large dividend yield of 5.2% annualized at a price of $125. More than likely, it’s a little bit of all the above happening in combination.
Image Source: IBM Blog
IBM’s massive research & development efforts and turning focus to artificial intelligence (AI), computer learning and automated decision making could be the “killer application” that sends the company’s profit growth into overdrive this decade. The large data supercomputer project Watson has been expanding its reach for decades already. Government agencies and big business customers may provide a rising tide of revenues as the world moves toward computer-based decision making, as now seen in the development of self-driving cars.
Image Source: Company website
According to IDC's latest survey, the worldwide AI market grew 36% to $28 billion during 2018. IBM led all companies with a 9.2% market share, as revenue rose to $2.58 billion. For IBM, AI revenues were 19% higher than 2017, driven by growth across software, hardware and services. During 2019, the company received 1,800 AI patents and had 30,000 client engagements. The Red Hat acquisition and its hybrid cloud focus is being integrated into AI offerings as I write this story.
Image Source: IDC Report
Red Hat also represents an aggressive push into cloud computing and storage for a worldwide clientele. Gartner listed IBM at #2 for public SaaS cloud market share, just behind Amazon's AWS (AMZN) in 2019, with an industry growth rate forecasted in the 15-20% range for 2020-21. On another growth front, IBM is "the" leader in enterprise blockchain solutions for a global supply chain. The company employed 2,000 blockchain experts in 2019, more than anyone else. In addition, IBM is the leader in financial transaction technology and use with an 80% market share. Plus, it still has a sizable hardware, software and services presence in the high-tech marketplace.
Fundamental Valuation
In terms of IBM’s debt position, net interest expense of $1.2 billion was reported the last four quarters. I am estimating a $1.6 billion annualized number at current interest rate and debt levels after a full year of Red Hat buyout borrowing has passed. The 3% expense rate on net debt (minus cash) of $55 billion is not as large a burden as one would expect, especially with $15 billion in cash flow generation last year. In fact, the $15 billion in annual cash flow creation compares relatively favorably with $95 billion in net liabilities after subtracting $38 billion in cash, receivables and other current assets. Taking 6.5x years of cash flow to theoretically pay off all net long-term liabilities is only slightly above the S&P 500 average equivalent around 5x.
Further, management has promised to pay off debt levels from the Red Hat deal as quickly as possible. After the common dividend payment of $5.7 billion is made, $9+ billion is left for capital expenditures, acquisitions, share buybacks and debt repayment. I am modeling a 24-month period of focused debt repayment for IBM to get back to a normal S&P 500 leverage position versus cash flow.
Another issue the new CEO needs to address is profit margins. Below is a 10-year chart of net income per employee and cash flow-to-debt. Ideally, financially strong organizations have long-term trend lines sloping higher, not lower for these comparisons. IBM just announced a reduction in headcount, expected to be in the thousands, to offset COVID-19 economic uncertainties and lagging operating segments.
The good news is IBM’s gross profit margin has remained remarkably stable the last decade. The main issue is the company's expanded financial leverage, ineffectively used to buy back shares, has hurt its final profit margins. Another problem has been IBM’s inability to find a growth driver for revenues.
Basic financial ratios of valuation indicate the stock is getting into bargain territory. Price-to-trailing earnings, sales, cash flow and accounting book value are the lowest they have been the past decade, pictured below. Using 2012 multiples, IBM is undervalued by roughly 40%. The difference in Wall Street pricing is the prevailing view of future results. Back in 2012, analysts had a rosier projection for the company’s prospects. Today, analysts and investors are quite negative on IBM’s ability to grow substantially. Can you blame them after eight years of declining revenues?
Not only are basic valuation metrics in the cheap range, but IBM’s rising dividend payout and yield for investors are worth consideration in today’s topsy-turvy economic environment. A 5.2% dividend yield at the current $125 stock price is 2.5x better than the S&P 500 yield of 1.9% and blows the risk-free U.S. Treasury rates of well under 2% out of the water. Plus, IBM has not cut the payout level of its dividend since 1993, when Lou Gerstner completely restructured the company, laying the foundation for stronger returns in the technology boom years. For 27 years, IBM has only raised the dividend over time.
Below you can review the expanding and compounding dividend picture since 2010. Standing at 35% of cash flow last year, well-diversified by geography, product line, and customer counts, IBM has a safer payout foundation than most. In comparison, Goldman Sachs is projecting a 25% cut in the dividend payout for the S&P 500 average, a consequence of the coronavirus pandemic effect on income for the U.S. economy.
Technical Picture
To be honest, since December, IBM has been experiencing the kind of buying trends stocks like Amazon, Apple (AAPL), Netflix (NFLX) and Facebook (FB) have witnessed for years. While the equity price initially popped to $155 in February, the COVID-19 economic shutdown and related market chaos have held the quote in check. (The CEO change was announced on January 30th, for reference.) However, underlying buying continues in IBM. Nearly all the health checkup indicators I follow are moving higher nicely. Below are three of many I watch, placed on a 12-month price chart.
The Accumulation/Distribution Line (ADL) has performed at a super-positive clip since late December. Marked with a green arrow, daily closing prices have generally been nearer the high trade of the day versus the low side. The Negative Volume Index (NVI) has done an admirable job of moving forward all year, despite a flat-to-lower stock price. Since its March price bottom, the NVI has moved straight up, an indication of plenty of buy interest on low-volume, quieter news days. The NVI high point over the last week is marked with a red arrow. Finally, the On Balance Volume (OBV) line started to streak higher right after the CEO change announcement. The coronavirus disruption has caused new sellers to appear, but the OBV line marked with a blue arrow has been zig-zagging higher again since March. Net-net more buyers than sellers have been a part of the equation on both low- and high-volume days, with aggressive buying during the day a common occurrence for IBM.
Final Thoughts
Can a new CEO make any difference in the stock quote? Yes, absolutely. I remember when Steve Jobs came back as CEO of Apple in 1997. The stock went nowhere after Jobs was replaced by John Sculley in 1983 all the way until 1997, despite a massive technology boom in America. The split-adjusted stock traded between $0.40 and $2.15 a share over the span Jobs went missing, and was priced at $0.60 when the co-inventor of the personal home computer was convinced to return.
Microsoft (MSFT) even felt so bad for the stumbling and bumbling of its main competitor in personal computer operating systems, it floated Apple money to stay in business as Jobs took the reins again! Of course, the rest is history as the tech visionary engineered/invented portable, solid-state, wireless internet-connected, touchscreen, mass-produced computer gadgets from iPads and iPods to iPhones, propelling the stock to its $320 price in 2020. Microsoft itself has flourished since 2014 after hiring its current CEO Satya Nadella. Time and again, innovative and focused leadership has been an important ingredient for big technology success.
I am personally trying to get into IBM shares a little lower in price. In previous articles last month, I have expressed my concern that the current bear phase in the market is not yet completed. It’s somewhat possible we will take out the lows of March with another 10-30% drawdown in the S&P 500 before the November election. In all likelihood, IBM would also decline under this scenario, perhaps "outperforming" by dropping at slower clip than the market. I would not be surprised by a price dip below $110 under a worst-case scenario, before a multi-year uptrend is put into motion. Nonetheless, starting a position at $125 will likely prove a smart decision one or two years from now. You can collect a 5.2% annual dividend while waiting, which may rise materially over time.
The way I trade my diversified long/short portfolio, IBM’s position as a long choice need only to rise faster or fall less in percentage terms than the S&P 500 for me to consider it a winner. I am projecting a period of 2-3 years of outperformance of the general stock market, especially if new CEO Arvind Krishna can turn IBM into an AI and blockchain profit growth machine. My annualized total return estimate of 15-20% for IBM should compare quite positively against a stagnant to slightly rising S&P 500 the next 24-36 months. Given today’s near-record overvaluation of the S&P 500 on underlying sales and earnings, its low dividend yield, and the cascading negative effects of the coronavirus recession, investors should temper their investment gain projections for stocks over the intermediate future.
Buying IBM in the coming weeks may put investors in the sweet spot of scooping up a bargain valuation on stagnant returns, just before improving operating results appear and Wall Street upgrades its valuation multiples on those surprisingly better numbers.
To review how my forecasts for IBM have changed over time, you can reread past articles on Seeking Alpha. My first effort in 2017 explained the substantial odds of IBM declining to a price under $100 a share in the next recession. Falling from $154 when I wrote the story 32 months ago, the quote hit a low of $90 in March. I also explained IBM’s propensity to spike in price around meaningful stock market peaks back in early February (as it did), just weeks before the U.S. economy was quarantined.
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Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in IBM over the next 72 hours. 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.
This writing is for informational purposes only. All opinions expressed herein are not investment recommendations, and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity and is not a registered investment advisor. The author recommends investors consult a qualified investment advisor before making any trade. This article is not an investment research report, but an opinion written at a point in time. The author's opinions expressed herein address only a small cross-section of data related to an investment in securities mentioned. Any analysis presented is based on incomplete information, and is limited in scope and accuracy. The information and data in this article are obtained from sources believed to be reliable, but their accuracy and completeness are not guaranteed. Any and all opinions, estimates, and conclusions are based on the author's best judgment at the time of publication, and are subject to change without notice. Past performance is no guarantee of future returns.
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Comments (54)
Good lock investing in IBM...
2012 $5.82B
2019 $5.99B An increase of 2.92%MSFT
2012 $10.01B
2019 $18.00B An increase of 79.82%AMZN
2012 $4.56B
2019 $35.93B An increase of 687.94% GOOGL
2012 $6.08B
2019 $26.02B An increase of 327.96%
www.zdnet.com/...
More risk?? Keep your risk parameters in place.
Same old song, get that 5% while you wait.
There will be a day, but it is a long time coming
80-9May peak my interest.
Best to all
GE
BA
JPM
O
XOM
CVS
MO
T
IBM
TRAVELERS
MMM
BAC
IVZ
AIRBUS
DAL
LUV
You know what they have in common undervalued
