International Business Machines (IBM 2.21%) turned in a positive direction following its first quarterly earnings report since the spinoff of Kyndryl Holdings (KD 3.28%). After routinely posting flat revenue growth numbers in past quarters, it delivered on its promise to deliver "mid-single-digit" revenue increases.
The tech giant endured years of struggle as it sought to transform itself into more of a cloud company, and it took nearly two years under the leadership of CEO Arvind Krishna to reach this point. Now, as a leaner company with a renewed focus, the question for investors is whether IBM can beat the market over the next three years?
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IBM's improved financials
IBM started its new future much stronger, reporting fourth-quarter revenue from continuing operations of $16.7 billion. This figure, which backs out what now is Kyndryl's business from the year-ago period's numbers, amounted to an increase of 6.5% compared with the year-ago quarter. The software and consulting segments led the way, growing revenue during that period by 8% and 13%, respectively. Also, hybrid cloud revenue across all segments came in at $6.2 billion, 16% more than last year.
Further down the income statement, this led to a Q4 net income of $2.3 billion, 72% more than in the year-ago quarter. Expenses dropped 25% to $6.6 billion, primarily due to lower sales and marketing costs, and general and administrative expenses. Even though the company paid $407 million in income taxes during the quarter, as opposed to a $175 million tax benefit in Q4 2020, it did little to offset the savings in operating expenses.
IBM did not offer guidance. However, for fiscal 2022, analysts forecast a 6% revenue increase and 24% profit growth on a consensus basis, pointing to a longer-term continuation of the Q4 performance.
In contrast, IBM's free cash flow reflects some adjustments with Kyndryl now out of the picture. IBM reported $6.5 billion in free cash flow for fiscal 2021, or $7.9 billion excluding charges related to the Kyndryl separation. This fell significantly from the $10.8 billion in free cash flow in 2020. It also came close to the $5.9 billion IBM spent on dividends in 2021.
Still, free cash flow should increase with rising profits and the separation charges behind it. The company forecasts $35 billion in cumulative free cash flow between 2022 to 2024, slightly exceeding pre-spinoff levels on average. Additionally, with a 4.8% yield and a 26-year history of payout hikes, the annual dividend of $6.56 per share should continue to make IBM stock attractive to income investors.
How the new IBM looks different
IBM has transformed itself numerous times in its 111-year history. Now that it has spun off its former managed infrastructure business, it has become primarily a cloud stock. The software and consulting segments combined, which accounted for around 70% of the company's revenue in Q4, drove most of the company's growth.
Moreover, with its purchase of Red Hat, it has worked to become the leader in the hybrid cloud, a cloud environment that allows public and private clouds to work seamlessly. IBM is far from the only hybrid cloud company. Nonetheless, Mordor Intelligence predicts a compound annual growth rate (CAGR) of 21% in this segment through 2026, increasing the likelihood that the hybrid cloud will continue to drive considerable revenue growth for IBM.
This broad-based growth stands in stark contrast to the fourth quarter of 2020. During that quarter, all segments of the company reported revenue declines, with the only double-digit growth coming from cloud revenue in two of the company's segments. Also, the segment which ran what is now Kyndryl at that time accounted for 32% of the company's revenue, not including infrastructure-related businesses still held by IBM.
Indeed, IBM still runs an infrastructure segment that delivered flat growth in the most recent quarter. But since that made up only 26% of the company's revenue, it did not affect its financials as significantly, a factor that helps reinforce IBM's reputation as a cloud company. Strong top-line growth in the software and consulting divisions more than made up for the lackluster infrastructure performance.
IBM in three years
Although predicting the future could involve unexpected challenges, IBM appears poised to outperform the market over the next three years. With Kyndryl spun off and the software and consulting segments driving significant growth, IBM is growing again and should meet its revenue and cash flow predictions.
Admittedly, some growth investors may continue to overlook IBM in favor of smaller, faster-growing tech stocks. Still, for stockholders wanting solid growth and a rising, steady stream of income, IBM appears positioned for a long-awaited comeback.
