IBM (IBM -1.05%) posted its second-quarter earnings report on July 19. The tech giant's revenue declined 0.4% year over year (but rose 0.4% on constant currency terms) to $15.5 billion, which missed analysts' expectations by $70 million. Its adjusted EPS declined 6% to $2.18 but still cleared the consensus forecast by $0.76.
IBM's stock dipped 1% during after-hours trading following that report, and it's declined about 5% year to date. Neither the bulls nor the bears seem too enthusiastic about IBM -- but is it worth buying as a long-term investment right now?
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IBM's growth is still cooling off
After divesting its managed infrastructure services segment as Kyndryl (KD -3.23%) in November 2021, IBM restructured its business into three divisions -- software (43% of its second-quarter revenue), consulting (32%), and infrastructure (23%).
IBM initially claimed its revenue would grow at a mid-single-digit rate between 2022 and 2024, with its mid-single-digit growth in software revenue and high-single-digit growth in consulting revenue offsetting the flattish growth of its infrastructure business. But it broadly missed those long-term targets over the past year as the macro headwinds intensified.
|
Revenue Growth by Segment (YOY) |
Q2 2022 |
Q3 2022 |
Q4 2022 |
Q1 2023 |
Q2 2023 |
|---|---|---|---|---|---|
|
Software |
6% |
7% |
3% |
3% |
7% |
|
Consulting |
10% |
5% |
1% |
3% |
4% |
|
Infrastructure |
19% |
15% |
2% |
(4%) |
(15%) |
|
Total Revenue |
9% |
6% |
0% |
0% |
0% |
|
Total Revenue (Constant Currency) |
16% |
15% |
6% |
4% |
0% |
Data source: IBM. YOY = Year-over-year.
The year-over-year growth of IBM's software and consulting businesses accelerated in the second quarter, but its infrastructure business struggled with tough comparisons to its successful launch of its z16 mainframe a year earlier. The gap between its reported and constant-currency growth rates also narrowed as the dollar stabilized. For the full year, IBM reiterated its outlook for 3%-5% constant-currency revenue growth. Analysts expect its reported revenue to rise 3%.
But its hybrid cloud and AI businesses are still expanding
IBM's biggest mistake over the past decade was losing the public cloud market to Amazon, Microsoft, and Alphabet's Google. Trying to catch up to those cloud giants would be futile, so IBM has been expanding its hybrid cloud ecosystem to analyze the data that flows between public cloud services and private clouds. The bedrock of that strategy is Red Hat, the open-source software developer IBM acquired for $34 billion in 2019. Open-source software is compatible with a wide range of cloud services and on-site applications, so Red Hat's hybrid cloud services can be easily wedged between the public and private clouds.
Red Hat's revenue rose 11% year over year in the second quarter and matched its growth rate in the first quarter. Within that total, its hybrid cloud platform OpenShift grew "more than 30%" in the first quarter, compared to its "north of 40%" growth in the second quarter, and generated $1.1 billion in annual recurring revenue (ARR).
That ARR only represented 2% of IBM's trailing 12-month revenue, but its robust growth suggests the hybrid cloud -- which appeals to larger companies that aren't ready to migrate all of their data to public cloud platforms -- is still expanding as the macro headwinds curb the growth of many larger public cloud companies. Deploying more hybrid cloud services to analyze all that data also gives IBM a firm foundation to launch more AI tools to help companies make smarter decisions.
Its free cash flow and profits are rising
IBM reiterated its outlook for generating $10.5 billion in free cash flow (FCF) this year, which would represent a 13% increase from 2022. That cash flow should easily cover its dividends, which consumed $5.9 billion of its FCF in 2022, and give it plenty of room to strengthen its hybrid cloud and AI platforms with new investments or acquisitions.
Analysts expect IBM's adjusted EPS to grow 3% for the full year. Its stock still looks cheap at 14 times forward earnings, and it pays an attractive forward yield of 4.9%.
Is it the right time to buy IBM?
IBM's divestment of Kyndryl, its acquisition of Red Hat, and the expansion of its hybrid cloud and AI platforms are enabling it to finally generate stable revenue growth again after years of stagnation. I believe that progress -- along with its low valuation, rising cash flows, and high dividend yield -- make it a great buy for conservative income investors right now.
