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IBM Plunges: 5 Reasons to Buy, 5 Reasons to Sell

By Leo Sun – Apr 23, 2018 at 10:30AM

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Investors are losing faith in Big Blue’s glacial turnaround.

Shares of IBM (IBM -0.22%) plunged nearly 8% on April 18, after the tech giant reported its first-quarter earnings. Big Blue's numbers initially looked solid, topping analyst estimates on both the top and bottom lines.

But upon digging deeper into the report, investors will find conflicting numbers that paint a murky picture of IBM's future. Let's compare the good news with the bad and see if this stock could rebound from its latest dip.

IBM CEO Ginni Rometty.

IBM CEO Ginni Rometty. Image source: IBM.

5 reasons to buy IBM

  1. IBM posted its second straight quarter of annual sales growth after almost six years of declines. Its revenue rose 5% annually to $19.07 billion, beating estimates by $390 million. Its non-GAAP earnings also grew 4% to $2.45, topping expectations by $0.06.
  2. IBM's closely watched "strategic imperatives" (SI) revenue -- which comes from its higher-growth cloud, social, mobile, security, and analytics businesses -- rose 12% annually (10% on a constant currency basis) to $37.7 billion over the past 12 months. That accounted for 47% of IBM's revenue, compared to 42% a year earlier. This tells us that Big Blue's shift from legacy businesses to higher-growth ones is gradually paying off. IBM also noted, without disclosing an exact figure, that its security revenues also rose 60% annually during the quarter.
  3. IBM's total cloud revenue over the past 12 months rose 22% annually (20% in constant currency) to $17.7 billion. For the quarter, its higher-growth cloud-as-a-service revenue rose 25% annually (20% in constant currency) to $10.7 billion, compared to 20% reported growth in the fourth quarter.
  4. Three of IBM's four computing business segments (Cognitive Solutions, Global Business Services, and Technology Services & Cloud Platforms) posted positive annual sales growth and topped analyst estimates.
  5. IBM's stock remains fairly cheap at less than 11 times this year's earnings, and it pays a forward dividend yield of 3.8%. That low valuation and high yield should limit its downside potential.

5 reasons to sell IBM

  1. IBM's total sales were buoyed by a weak dollar. On a constant currency basis, its revenue actually stayed flat year over year during the quarter. On a constant currency basis, its Global Business Services and Technology Solutions & Cloud Platforms revenue would both have declined 1% annually. Its Cognitive Solutions revenue rose 6% in dollars, but just 2% on a constant currency basis.
  2. The soft dollar took a big bite out of its Systems revenue, which rose 8% in dollars but just 4% in constant currency terms. That growth completely missed the consensus estimate of 21% growth on a dollar basis. Within that unit, robust demand for mainframes and Power servers failed to offset a 15% decline in storage revenue. That decline in storage revenue was disappointing, since its rivals Hewlett-Packard Enterprise (HPE 0.25%) and NetApp (NTAP -0.13%) both recently reported solid storage sales growth. HPE's storage revenue rose 23% annually last quarter on a constant currency basis, while NetApp's product revenue grew 17% annually in its latest quarter.
  3. IBM's adjusted gross margin dropped 70 basis points annually to 43.7%. After excluding restructuring expenses for its Systems unit, it still declined 30 basis points to 44.1%.
  4. IBM also benefited from a low adjusted tax rate of 16%. BMO analyst Keith Bachman, who claims IBM has "some work to do," pointed out that IBM might have missed estimates without that tax benefit.
  5. IBM still expects its earnings and free cash flow (FCF) to dip this year. It reiterated its guidance for an EPS of "at least" $13.80 this year, compared to $13.92 in 2017; and an annual FCF of $12 billion, down from $13 billion last year.

Is it time to buy IBM?

IBM's numbers are looking better, but its slower-growth software, hardware, and IT services are still throttling the growth of its strategic imperatives. Its overall growth is inflated by a weak dollar and tax benefits, which makes it difficult to measure IBM's real growth.

Meanwhile, tougher competition from rivals like HPE and Microsoft could put more pressure on its margins, earnings, and FCF. That's why many investors, including Warren Buffett, are losing patience with Big Blue. IBM's downside might be limited, but the stock can't rally until the company generates better growth.

Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Leo Sun has no position in any of the stocks mentioned. The Motley Fool is short shares of IBM. The Motley Fool has a disclosure policy.

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