Image Shown: IBM rallies back after third-quarter results October 18.
IBM has been shunned by investors since it bailed on its operating earnings per share target of $20 a few years ago. The market, however, was recently relieved that IBM reiterated its full-year 2017 expectations calling for operating earnings per share of at least $13.80. Many are hoping for a comeback.
By Brian Nelson, CFA
Here’s what we wrote about IBM (IBM) in July after its second-quarter results:
IBM took its eye off the ball years ago with misaligned executive incentive plans focused on operating earnings per share targets, and it is still feeling the pain. Warren Buffett has recently soured on the company’s long-term promise, and we even use Big Blue as the poster child for our educational walk through of what constitutes poor earnings quality. The company’s top line shows no signs of turning for the better after more than 20 consecutive quarters of declines. The competitive environment at IBM is not getting any easier, and while the company remains a strong free-cash-flow generator, we’re not enthused by its revenue erosion at all. In its second quarter, results released July 18, total revenue fell 5%, as reported, and 3% after adjusting for currency. Management is targeting operating diluted earnings per share of at least $13.80 and GAAP earnings per share of at least $11.95, a far cry from previous $20 operating earnings per share targets set many years ago. We value shares of IBM at ~$160 each, though its current share price doesn’t offer a large enough margin of safety for us to become interested in shares.
IBM closed near $160 per share the trading session following the release of its third-quarter results, up nearly 9% October 18. Though third-quarter performance revealed the 22nd consecutive quarter of declining revenue, the Street’s expectations had been set so low that IBM was able to hurdle them on both the top and bottom line. The company’s reiteration of its full-year operating earnings per share target of at least $13.80 was also reassuring, and many are starting to think the company has hit an “inflection” point. We think it’s a bit too early to say that IBM has finally turned the corner, but the market is a forward-looking mechanism, and we think buyers are trying to get in before confirming fundamentals.
To be sure, IBM has some pockets of strength in its business. What it calls ‘strategic imperatives revenue’ (about 45% of total revenue) advanced 10% over the trailing 12 months, while ‘cloud revenue’ increased 25% on a year-over-year basis (also over the trailing 12 months). Management continues to speak positively about its “enterprise cloud leadership” and the adoption of its new z Systems mainframe. Big Blue remains a veritable cash machine, generating free cash flow of $2.5 billion in the quarter; its balance sheet is strong, but it could be better (the company holds $11.5 billion in cash and $45.6 billion in debt, including financing debt). We think IBM is fairly valued at the moment, but shares are yielding north of 4%. IBM’s Dividend Cushion ratio is 1.3.
What is the Dividend Cushion ratio?
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