IBM's (IBM 1.94%) stock slumped 4% on Jan. 26 in response to its fourth-quarter report. The tech giant's revenue stayed flat year over year, and rose 6% in constant currency terms to $16.7 billion, which beat analysts' expectations by $320 million. Its adjusted earnings rose 7% to $3.60 per share but missed the consensus forecast by a penny.
Those sluggish growth rates weren't surprising, since IBM had already told investors to brace for tough macro and currency headwinds over the past few quarters. However, its stock has stayed nearly flat over the past 12 months -- and outperformed the S&P 500's decline of nearly 7% -- as its low valuation and high dividend yield made it a safe haven play in this ongoing bear market. Can IBM still generate stable growth and outperform the market over the next 12 months?
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Reviewing the "new" IBM's priorities
IBM spun off its legacy managed infrastructure services unit as Kyndryl (KD 2.58%) last November. It subsequently restructured its business into three simpler segments: Software (41% of its revenues in 2022), consulting (32%), and infrastructure (25%). The remaining 2% came from its financing segment and other smaller businesses.
IBM initially claimed that between 2022 and 2024, it could grow its software revenue by the mid single digits and its consulting revenue by the high single digits, and maintain roughly flat growth for its infrastructure business every year. It also claimed its total revenues would rise at a mid-single-digit rate.
Unfortunately, the growth of all three businesses decelerated and fell short of IBM's pre-spinoff targets over the past year, and the rising dollar exacerbated that slowdown by creating a massive gap between its constant currency and reported revenues.
|
Period |
Q1 2022 |
Q2 2022 |
Q3 2022 |
Q4 2022 |
|---|---|---|---|---|
|
Software revenue growth (YOY) |
12% |
6% |
7% |
3% |
|
Consulting revenue growth (YOY) |
13% |
10% |
5% |
1% |
|
Infrastructure revenue growth (YOY) |
(2%) |
19% |
15% |
2% |
|
Reported revenue growth (YOY) |
8% |
9% |
6% |
0% |
|
Constant currency revenue growth (YOY) |
11% |
16% |
15% |
6% |
Data source: IBM. YOY = Year-over-year.
That slowdown indicates that IBM's ongoing shift toward hybrid cloud and artificial intelligence (AI) services, which has mainly been driven by its subsidiary Red Hat, won't completely insulate the company from the macro challenges.
IBM's trailing 12-month hybrid cloud revenues rose 17% on a constant currency basis to $22.4 billion, or 37% of its top line, at the end of 2022. But that still marks a slowdown from its 20% growth in the third quarter, and suggests it will struggle to expand as more companies rein in their cloud spending in this tough macro environment. That reduced spending will also curb the growth of its consulting business -- which relies mainly on large companies and is heavily exposed to currency headwinds -- and its infrastructure division, which depends on cyclical upgrades of high-end servers, mainframes, and storage hardware.
To further complicate matters, IBM is still doing a lot of business with its former subsidiary Kyndryl -- which accounted for four percentage points of its total sales growth in 2022. Big Blue expects that percentage to decline over the long term, but it could also decouple from Kyndryl too quickly, before the near-term macroeconomic and currency headwinds dissipate.
NYSE: IBM
Key Data Points
What does IBM think will happen in 2023?
In 2022, IBM's revenue rose 6% (and 12% in constant currency terms) to $60.5 billion. It generated $9.3 billion in free cash flow (FCF), and its adjusted earnings per share (EPS) grew 15%. However, most of that growth occurred in the first half of the year, and it clearly lost its momentum in the second half.
In 2023, it expects its revenue to remain "consistent with its mid-single digit model" as the currency headwinds wane in the second half of the year, and for its annual FCF to grow about 13% to $10.5 billion. Analysts expect its reported revenue and earnings to rise 1% and 6%, respectively, for the full year. That outlook isn't exciting, but it would represent a huge improvement from the years of declines it had experienced prior to its spin-off of Kyndryl.
It also indicates that CEO Arvind Krishna's long-term plan to reboot IBM by expanding its hybrid cloud and AI businesses (within a defensible niche between public and private clouds) could pay off. That said, investors should take all those estimates with a grain of salt, since the macro and currency headwinds could drag on as interest rates continue to rise.
Where will Big Blue's stock be in a year?
IBM's stock currently trades at 15 times forward earnings, and it pays a forward yield of 4.7%. That low valuation and high yield should limit its downside potential this year, but it probably won't rally much higher if its three core growth engines stall out. I still expect IBM to post flat to moderate gains in 2023, so it should remain a safe haven stock if the bear market drags on. But investors looking for bigger gains should check out some other undervalued tech stocks instead.
