The vast majority of analysts that follow International Business Machines (IBM +1.98%) rate the stock a hold. That's not too surprising, given that shares of the century-old tech giant have gone nowhere since 2011. A half-decade of declining revenue and a transformation that was slow to show tangible results kept most analysts on the sidelines.
One analyst changed his tune on Wednesday. John Roy of UBS upgraded IBM stock to "buy," joining just a handful of other analysts that see the beaten-down stock as a solid investment opportunity. Roy also boosted his price target on the stock by $20 to $180, representing nearly 20% upside from the current market price.
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Sustainable growth
In a note to clients on Tuesday, Roy predicted that sustainable growth for the company is in the cards. IBM returned to revenue growth in the fourth quarter of 2017 and has now reported three consecutive quarters of growth.
A survey of IT executives performed by UBS showed strong demand for IBM services, artificial intelligence, and cloud computing products, Roy said. The analyst expects IBM will beat earnings expectations next year, potentially leading the market to reassess the earnings multiple it assigns the stock. Based on IBM's non-GAAP earnings guidance for 2018, the stock currently trades for just 11 times earnings.
Roy sees IBM producing earnings of $14.25 per share in 2019, above the $14.04 consensus and about 3.2% higher than the $13.80 per share IBM expects to produce this year.
This growth will be driven by IBM's "strategic imperative" businesses, which now account for nearly 50% of the company's revenue. IBM's cloud computing business generated $18.5 billion of revenue over the past 12 months, and cloud delivered as-a-service is now at an $11.1 billion annual run rate.
In the longer term, IBM's blockchain efforts could produce a considerable amount of revenue for the company. Retailer Walmart announced earlier this week that it would require some suppliers to use IBM's blockchain to track food through the supply chain. That win could snowball into something much bigger if the grocery industry at large eventually adopts IBM's platform.
A few headwinds
IBM's long-term growth potential is clouded by some near-term issues. The company began shipping its latest mainframe system at the end of the third quarter of 2017, which means it laps that launch in the third quarter of this year. Mainframe sales typically spike after a new system is launched but soon normalize, leading to year-over-year sales declines.
Mainframe sales may decline in the third quarter and will almost certainly decline in the fourth quarter. That will create a revenue hole that IBM's growth businesses will need to fill for the company to keep its growth streak alive.
The other issue is currency. The bulk of IBM's revenue comes from overseas, so any strengthening of the U.S. dollar leads to negative currency translation effects. Roy sees currency headwinds hurting IBM's top line, although he believes currency and the mainframe cycle are already priced into the stock.
A cheap stock
Could IBM stock rise to $180? Absolutely. The company's fundamentals already support a higher stock price. A company like IBM, with significant competitive advantages and a century-long record of adaptation, should not be trading at such a beaten-down valuation.
If IBM hits its $13.80 per-share earnings target this year, that $180 price target represents a price-to-earnings ratio of just 13. For comparison, database giant Oracle, which has a much less convincing cloud strategy and has begun to hide its cloud growth numbers, currently trades for more than 15 times the average analyst estimate for full-year earnings. That valuation gap makes no sense to me.
On top of a discount valuation, IBM stock sports a dividend yielding about 4.1%. Not only is there a good chance of capital appreciation driven by earnings growth and multiple expansion, but investors will get paid a handsome sum for their time.
Analyst upgrades and downgrades should never be the only reason behind buying or selling a stock. But in this case, UBS hits the nail on the head.
