Tech stocks have taken a beating this year as inflation climbed. For example, game development platform inventor Unity Software shares dropped 80%. Yet for most of 2022's first half, the stock of IBM (IBM -0.32%) fared better than many of its tech brethren, even hitting a 52-week high of $144.73 in June.
IBM defied the market's first-half downturn thanks to its rising revenue and hefty dividend, currently yielding around 5%. But the tide turned after IBM announced second-quarter earnings in July.
The stock dropped from nearly $140 per share to below $130 after the earnings release because IBM lowered its free-cash-flow guidance for 2022. Big Blue's ability to generate free cash flow (FCF) is important to the company's financial strength, including paying its dividend.
But any fears about the dividend fail to take into account that the IBM of 2022 is substantially different from its pre-pandemic incarnation. The company now offers investors much more than just an attractive dividend.
What happened to IBM's free cash flow?
Let's first examine the drop in FCF guidance. Declining FCF can adversely affect IBM's ability to raise its dividend (which it has done for 27 consecutive years), or worse, force the company to cut the dividend as many companies did after the pandemic struck.
But IBM's free cash flow challenge is the result of multiple macroeconomic factors that will subside over time. For instance, a strong U.S. dollar is hurting IBM because about half of its second-quarter revenue came from international markets.
And after Russia's attack on Ukraine, IBM shut down its Russian operations. While sales from that country accounted for less than 1% of 2021 revenue, the business had high margins, squeezing IBM's profits and cash flow.
This combination of macroeconomic factors led to a revised forecast of $10 billion in FCF for the year instead of the previous range of up to $10.5 billion. Even so, management expressed confidence in achieving $35 billion in total FCF from 2022 through 2024.
So over the long run, IBM is poised to meet its dividend commitments. The company's ability to do so is thanks to the recent transformation of its business into revenue growth.
A rejuvenated business
Under CEO Arvind Krishna, who took over in 2020, IBM's focus shifted to hybrid cloud computing, which combines public and private cloud environments.
This is a popular IT infrastructure model among industries such as finance, where sensitive data requires a private cloud while lower-cost public cloud components are leveraged for other business needs. IBM's pivot has proved successful, with hybrid cloud revenue up 16% to $21.7 billion over the trailing 12 months.
IBM's cloud offerings are complemented by its infrastructure business, which sells hardware needed for private cloud environments. In the second quarter, the company released its latest mainframe computer system, the IBM z16. This model is the company's first to include a chip specifically designed for artificial intelligence (AI), and it's a hit. IBM z Systems' second-quarter revenue was up 69% year over year.
Its cloud computing and infrastructure capabilities are capped by IBM's consulting arm, which helps customers select and implement its technology. The consulting division delivered 10% year-over-year revenue growth in the second quarter. IBM expects consulting sales to continue growing by double digits this year.
The triumvirate of cloud computing, infrastructure, and consulting translated into strong 2022 performance. Second-quarter revenue was up 9% year over year to $15.5 billion. This followed the first quarter's $14.2 billion, which was an 8% year-over-year revenue increase.
The reasons for IBM's continued success
The company expects revenue growth to continue. Third-quarter sales are forecast to increase in the high single digits in constant currency. IBM should also achieve its goal of hitting $3 billion in revenue growth this year. The company's 2022 revenue is already up over $2 billion compared to last year.
Moreover, IBM's business is helped by the tailwind of industry growth. The hybrid cloud-computing market is expected to expand from $56 billion in 2020 to $145 billion by 2026.
The company's future looks bright as it continues to evolve its technology. As part of its cloud offering, it now provides access to a quantum computer that can process complex sets of data that even today's supercomputers can't handle. Banks and governments have begun using this capability, such as HSBC.
Also, IBM's decades-long history with AI technology makes it a leader in this space. For example, fast food giant McDonald's is using IBM's AI capabilities to test an automated drive-thru.
This success shows the company's transformation is paying off. Big Blue is no longer just a dividend play. It's positioned for long-term revenue growth, making IBM a well-rounded investment.