IBM (IBM 0.80%) just reported Q2 2022 earnings that topped expectations. The old computing technologist has a fresh look after parting ways with a big chunk of its legacy operations last year (the managed infrastructure company now known as Kyndryl (KD 0.17%)), and IBM's new focus on the hybrid cloud segment is paying off.
IBM has been a market-beating stock so far this year (down 2%, versus an 18% drop for the S&P 500 index) thanks to this revamped look, but at least one issue had the market feeling a little blue following the second-quarter update. Here's what happened.
Two reasons IBM is a buy right now
1. The cloud has revenue soaring. IBM doesn't put up sizzling growth numbers like its cloud giant peers Amazon AWS or Microsoft Azure, but it certainly has a new lease on life after narrowing its tech proficiency. Q2 revenue was up 16% year-over-year to $15.5 billion (when excluding foreign currency exchange rates), blowing away the old IBM that just last year was doing great if it reported a mid-single-digit percentage growth rate.
Propelling IBM higher were tech infrastructure sales, which increased 25% excluding currency exchange thanks to a new generation of Z Systems cloud and hybrid cloud computers, and consulting, which grew 18% (excluding foreign currency), helped by a string of acquisitions and organizations in need of assistance transforming their operations for the cloud era.
2. Free cash flow is on the rise. IBM realized some one-time expenses related to offloading Kyndryl. However, profitability (as measured by free cash flow) could be ready for a big jump higher, as the new IBM is much leaner than before.
Through the first half of 2022, the company reported free cash flow of $3.3 billion, compared to just $2.6 billion in the first half of 2021. For full-year 2022, IBM still expects to generate $10 billion in free cash flow, up from $6.5 billion in 2021. Based on a current enterprise value of $168 billion, IBM trades for just under 17 times current-year expected free cash flow. Not bad for a respectable revenue expansion rate and a stock that currently pays a 4.7% annual dividend yield.
One reason to sell IBM
There has been a big headwind thus far in 2022 that negatively impacted IBM as well: a strong U.S. dollar.
When a multinational corporation generates revenue overseas, it has to convert that foreign currency back into U.S. dollars when reporting financial results. With the U.S. dollar up sharply this year (yet another side effect of the Federal Reserve's aggressive interest rate hikes in an attempt to beat back inflation), actual reported revenue is being downwardly revised.
IBM is no exception. While currency-exchange-neutral revenue was up 16% year over year in Q2, actual revenue was up only 9% when accounting for negative exchange rates. Ouch. With the Fed still planning on more interest rate hikes this summer, this effect isn't likely to abate. IBM said reported revenue for full-year 2022 will be at the high end of its mid-single-digit percentage long-term projection, but likely lowered from what would be a mid-teens percentage growth rate when excluding currency exchange.
A strong dollar isn't the end of the world -- IBM is still growing sales and, more importantly, growing profits. Nevertheless, it does put a dent in results. Perhaps this headwind will turn into a tailwind if the Fed stops its rate hikes or even lowers rates (maybe in 2023?) and the dollar gives back some of its gains versus foreign currencies. In the meantime, though, if you're looking for a solid stock that can generate income, give IBM a look after its Q2 earnings update.