IBM (IBM 1.09%) posted a mixed first-quarter report on April 19. The tech giant's revenue rose 0.4% year over year (4.4% in constant currency terms) to $14.3 billion, which missed analysts' estimates by $30 million.
Its adjusted earnings dipped 3% to $1.36 per share but easily cleared the consensus forecast by $0.69. The stock held steady after the report, but it's still down about 10% this year. Should investors pick up some shares of Big Blue right now?
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Another quarter of decelerating revenue growth
IBM streamlined its business by divesting its managed infrastructure services segment as Kyndryl (KD 2.79%) in November 2021. It subsequently restructured itself into three simpler segments: Software (which produced 41% of its first-quarter revenue), consulting (35%), and infrastructure (22%).
When IBM spun off Kyndryl, it claimed its total revenue would grow at a mid-single-digit rate between 2022 and 2024. It had expected its software revenue to rise by the mid single digits, its consulting revenue to grow by the high single digits, and its infrastructure revenue to remain roughly flat. Unfortunately, all three of those businesses experienced significant slowdowns and fell short of those long-term targets over the past year.
|
Segment |
Q1 2022 |
Q2 2022 |
Q3 2022 |
Q4 2022 |
Q1 2023 |
|---|---|---|---|---|---|
|
Software revenue growth (YOY) |
12% |
6% |
7% |
3% |
3% |
|
Consulting revenue growth (YOY) |
13% |
10% |
5% |
1% |
3% |
|
Infrastructure revenue growth (YOY) |
(2%) |
19% |
15% |
2% |
(4%) |
|
Reported revenue growth (YOY) |
8% |
9% |
6% |
0% |
0% |
|
Constant-currency revenue growth (YOY) |
11% |
16% |
15% |
6% |
4% |
Data source: IBM. YOY = Year-over-year. Percentages rounded to the nearest full number.
Like many other enterprise-oriented tech companies, IBM's growth was throttled by macroeconomic challenges and currency headwinds -- which created a big gap between its reported growth rates and its constant-currency growth rates. However, that gap has notably narrowed over the past year as the dollar retreated from its 20-year highs.
For the full year, IBM expects its revenue to rise anywhere from 3% to 5% on a constant-currency basis. On a reported basis, analysts expect its revenue to grow just over 3% -- which assumes the dollar will continue to soften over the next three quarters.
Its cloud business continues to grow
IBM believes the expansion of its cloud ecosystem, which relies heavily on its subsidiary Red Hat, will drive its long-term growth. It uses Red Hat's open-source software to process the data that flows between public and private clouds.
That flexible "hybrid cloud" approach enables IBM to profit from the growth of the cloud market without going head-to-head against dominant public cloud infrastructure platforms like Amazon Web Services (AWS) and Microsoft's Azure. IBM then crunches all of that data with its growing portfolio of artificial intelligence (AI) services.
IBM divested Kyndryl to free up more resources for the expansion of its hybrid cloud and AI businesses. Red Hat's revenue rose 8% year over year (11% in constant-currency terms) in the first quarter and drove most of its software growth. Management expects that segment's revenue to grow another 11% to 13% in constant-currency terms for the full year.
Its margins are expanding and its cash flows are rising
IBM's gross margin expanded 90 basis points year over year to 52.7% in the first quarter, driven by the rising gross margins across all three of its core businesses. It attributed that expansion to a favorable mix of higher-margin products. Its pre-tax income margin also rose to 7.4%, up from 4.4% in the year-ago period, as IBM laid off thousands of employees and reined in its spending.
As a result, IBM expects its free cash flow (FCF) to rise from $9.3 billion in 2022 to about $10.5 billion in 2023. That cash should easily cover its dividends, which consumed $5.9 billion of its FCF last year, and provides plenty of room to expand its hybrid cloud and AI ecosystem with fresh investments. Analysts expect its adjusted earnings to grow 4% for the full year.
A cheap stock with a generous yield
IBM still faces near-term challenges. The macro headwinds could persist, while Kyndryl -- which accounted for 4 percentage points of IBM's sales growth in 2022 -- could pivot away from IBM's products and services as it shops around for better deals. But over the long term, IBM could carve out a defensible niche with its open-source hybrid cloud and AI services.
It's also exercising tighter financial discipline, revenue is climbing again, and its stock looks cheap at 13 times forward earnings. Its hefty forward dividend yield of 5.2% should also limit its downside potential in this tough market. IBM won't generate explosive gains, but it's still a good safe-haven stock to buy and hold as we wait for the next bull market to start.
