by Larry Gellar
IBM's (NYSE:IBM) stock has retreated since the company's earnings report on Tuesday, and I'm sensing a buying opportunity. First, let's review some key facts from the earnings report. Although net income was up 7% year-over-year for the first quarter, revenue was essentially unchanged. Analysts were expecting a slight uptick in revenue, although IBM was able to beat estimates for earnings per share.
I think investors need to look at the big picture here and ask if the unchanged revenue is really a problem. In my opinion, it is simply the product of an ongoing shift at IBM. The company is moving away from hardware and more toward software and services. More specifically, the increase in net income was not all due to cost-cutting measures that will hurt future growth - it was simply due to a change in the nature of the business. Although revenue was unchanged in this earnings report, I expect IBM to see revenue increases going forward as it continues to adjust its business model. Additionally, while the unchanged revenue certainly is a piece of bad news, I believe that the stock has been punished too much for this issue. At the time of this writing, IBM stock was below $200, and that certainly puts it in the buy territory for me.
Other parts of the IBM earnings release were also important indicators of the strength of the company's business. For instance, IBM expects adjusted earnings per share to be $15 for the full year, and that's a notable increase from its previous outlook of $14.85. Analysts were expecting $14.93, and investors should certainly take this optimism on IBM's part seriously. In fact, IBM is even hoping to get to $20 of adjusted earnings per share for the year of 2015. Considering the biggest companies are also the ones least likely to put out a bold number like that, I think this is a sign that IBM has a very clear idea of what it wants to do. Meanwhile, I'm also impressed with the exact breakdown of IBM's revenue changes. Software revenue was up 5% and technology services revenue was up 2%, while hardware revenue was down 7% and business services revenue was down 2%. In my opinion, the hardware revenue decreases will level out at some point in the near future, which will still leave IBM with a well-sized hardware business.
IBM also discussed the sale of its Retail Store Solutions business to Toshiba during its earnings release, and this too is a move I like. This gives IBM a chance to unload yet another one of its lower-margin businesses to a different company that will probably be able to utilize it better. For the price of $850 million, Toshiba will get new non-Japanese exposure that could help it to increase its pool of customers overall. Additionally, the deal provides for opportunities for Toshiba to work with IBM. This is great for IBM as it expands its Smarter Commerce initiative, and Toshiba is obviously getting a great business partner.
The earnings release as a whole has gotten different reactions from Wall Street analysts, but many of the reports I'm seeing are in agreement with my own analysis. For instance, Shaw Wu of Sterne Agee is keeping his Buy rating and a price target of $230. Specifically, Mr. Wu noticed that gross margin and profitability measures improved nicely, and I too believe this is an important part of the IBM story. Richard Gardner of Citigroup (NYSE:C) also had good things to say. He too has a Buy rating, and Mr. Gardner actually raised his price target from $205 to $235. In fact, Mr. Gardner noted that some of IBM's weakness may be due to government spending trends in Japan, so this could simply be an anomaly of the first quarter.
Outside of the earnings report, IBM's ratios and other statistics look good to me. IBM has a lower price-to-sales ratio (2.17) than Microsoft (NASDAQ:MSFT), EMC and Oracle (NYSE:ORCL), and IBM's price-to-earnings ratio is reasonable too at 15.27. IBM does have significant lower margins (14.83% net, 46.89% gross, 24.57% EBITD, 19.64% operating) than Microsoft and Oracle, but that's obviously due to the differences between the companies' focuses. If anything, I believe the difference in margins gives even more weight to IBM's plans to move into higher-margins businesses. After all, if Microsoft and Oracle can have terrific margins, IBM should be able to improve its margins too.
In addition to the news of the earnings report, IBM recently announced that it is acquiring Varicent Software. This Canadian software company specializes in compensation and sales performance, so this is clearly an important piece for IBM's analytics portfolio. In fact, IBM has made similar acquisitions lately including Algorithmics, Clarity Systems, OpenPages, Cognos and SPSS. Here's what Dan Shimmerman, CEO of Varicent, had to say about the acquisition: "As part of IBM, we can now bring our technological expertise in maturing and advancing the efficiency and effectiveness of the sales function to a broader range of clients across the globe."
IBM only offers a dividend yield of 1.4%, significantly less than Microsoft's 2.5%, so investors looking for supplemental income may wish to look elsewhere. For those who are okay with the small dividend, though, IBM is a great choice, and the latest cash flows are one last thing I recommend investors take a look at. Although IBM had a net outflow of cash in the first quarter, stock repurchases were a big reason for that. That can be taken as yet another sign of this management team's confidence, and operating cash inflows were terrific at $4.2 billion. In my opinion, IBM is a clear buy right now, especially given the pullback it experienced after its earnings report.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.