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One Month After Beating Earnings, Is IBM Stock Due for a Breakout?

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A month has gone by since the last earnings report for International Business Machines (IBM - Free Report) . Shares have added about 2.22 % in the past month, posting a performance that is largely in-line with the market for that time frame.

Will this trend continue? Or will IBM be able to break out from here and put some distance between its performance and the S&P 500?  Before we dive into how investors and analysts have reacted as of late, let's take a quick look at the most recent earnings report in order to get a better handle on the important drivers.

Recent Earnings

 

IBM reported third-quarter 2016 non-GAAP earnings of $3.29 per share and revenues of $19.23 billion, which comfortably surpassed the respective Zacks Consensus Estimate of $3.21 and $19.01 billion.

After declining for 17 consecutive quarters, revenues were almost flat on a year-over-year basis driven by strong growth from strategic imperatives and cloud. However, earnings declined 1.5% from the year-ago quarter due to a lower gross margin base and higher research & development expenditure.

IBM has been moving away from its traditional businesses to newer (read more lucrative) business avenues like cloud and data analytics. Though IBM’s strategic imperatives are performing well, third-quarter results showed that these are not sufficient to compensate for the weakness in its traditional businesses yet.

Segment Revenue Details

Total software revenue increased 3% year over year to $5.7 billion.

Cognitive Solutions (solutions software and transaction processing software) revenues grew 4.5% year over year to $4.24 billion. Software solutions registered growth of 8%, driven primarily by analytics (Watson platform, Big Data, Information Integration). Cloud was up an impressive 74%. Acquisitions continue to cushion growth.

Revenues at the Global Business Services (includes consulting, global process services, application management) segment were $4.19 billion, roughly in line with the year-ago quarter. Segmental revenues pertaining to strategic imperatives were up 13%.

Revenues at Technology Services and Cloud Platforms (includes infrastructure services, technical support services, integration software) grew 2.4% to $8.75 billion. Segmental revenues pertaining to strategic imperatives surged 45% driven by robust performance of hybrid cloud.

Revenues at Systems (systems hardware and operating systems software) fell 21% on a year-over-year basis to $1.56 billion. Hardware revenues tanked 25%, while operating systems slumped 11%.

Global Financing (includes financing and used equipment sales) revenues declined 7.8% to $412 million.

Strategic Imperatives

IBM’s strategic imperatives (cloud, analytics, mobility and security) revenues surged 16% on a year-over-year basis to $8.3 billion in the quarter. Cloud revenues jumped 44% while Analytics revenues increased 15% during this period. Revenues from mobile and security increased about 19% and 11%, respectively.

Per IBM, strategic imperatives now represent 40% of the company's top line and have delivered revenues of almost $32 billion over the last 12 months.

IBM continues to expand its cloud footprint by announcing new cloud centers in South Korea and Norway during the quarter. The company now has 49 cloud centers.

During the quarter, IBM entered into a partnership with Workday and an extended relationship with VMware. Workday will now use IBM cloud for software development and testing purposes, while the extended relationship with VMware will enable easy hybrid cloud adoption.

Expanding Watson Offerings

IBM continues to expand its Watson offerings. During the quarter, the company introduced Watson Conversation Service and Watson Virtual Agent for Customer Service. The service has already been selected by the likes of The Royal Bank of Scotland Group plc.

Additionally, IBM launched Watson for Drug Discovery and Watson Health Core. The company also entered into a partnership with Siemens to help healthcare providers deliver value-based care to patients with chronic conditions such as heart disease and cancer.

IBM believes that the partnership with Siemens will accelerate adoption of Watson’s Population Health Management offerings in the U.S. Further, the company noted that it has won customers in China, South Korea, Finland and the United Kingdom.

IBM is focused on developing capabilities around th Blockchain technology. It is now working with almost 300 clients including the likes of CLS and Bank of Tokyo-Mitsubishi. Moreover, the company announced a Blockchain innovation center in Singapore.

Guidance

For full-year 2016, IBM continues to project non-GAAP earnings to be at least $13.50. Further, the company continues to anticipate generating free cash flow at the high end of the earlier expected range of $11 billion to $12 billion.

 

How have estimates been moving since then?

Following the release and in the last month, investors have witnessed a downward trend for fresh estimates. In the past month, there have been seven revisions lower for the current quarter compared to zero higher, a pretty negative trend overall.

VGM Scores

At this time, IBM's stock has just an average Growth score of 'C', however, its momentum grade is doing a lot better with an 'A'. Charting a somewhat similar path, the stock was allocated a grade of 'B' on the value side, putting it in the second quintile for this investment strategy. 

Based on our scores, the stock is primarily suitable for momentum investors while also being suitable for those looking for value and to a lesser degree growth.

Outlook

While estimates have been broadly trending downward for the stock, the magnitude of these revisions indicates a downward shift. Interestingly shares of IBM have a Zacks Rank # 3 (hold), so we are expecting a continued in-line performance from IBM in the next few months.

We think the company is just a hold right now. IBM could be considered a decent choice for value investors, but the lack of growth on the earnings estimate front is definitely concerning and needs to be monitored closely.

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