International Business Machines (IBM 1.56%) will report its second-quarter earnings on July 20 after market close. IBM's stock has been stuck in a rut all year, sitting well below its 52-week high of nearly $200 per share.
IBM's first quarter didn't bring any major surprises. Revenue was flat adjusting for currency and divestitures, and the company's profits rose, driven by cost cuts. IBM's mainframe business doubled thanks to the release of the new z13 system, and cloud revenue continued to rapidly rise, growing by 75%. The company maintained its previous earnings guidance, expecting full-year non-GAAP EPS between $15.75 and $16.50.
What analysts are expecting
Analysts aren't expecting much from IBM during the second quarter. The average analyst estimate for revenue calls for a 14.1% year-over-year decline. Part of this decline will be due to businesses that IBM has divested over the past year, as well as currency issues. During the first quarter, IBM's unadjusted revenue fell by 12% year over year.
Analysts are expecting IBM's non-GAAP earnings to decline during the second quarter to $3.79 per share, down from $4.43 per share during the second quarter of 2014. IBM has beaten analyst estimates for earnings in three of the past four quarters, and during the first quarter the company's non-GAAP earnings increased year over year. With expectations so low, there could be another earnings beat in the cards.
What investors should look for
While the headline numbers are important, there are a few specific things that IBM investors should pay attention to. First, IBM has made a big deal about its strategic imperatives. These are areas of IBM's business that it expects to grow from $25 billion in revenue to over $40 billion in revenue over the next few years. Essentially all of IBM's growth will come from these businesses, which include cloud, analytics, security, and mobile and social.
During the first quarter, IBM posted strong growth in these areas. Analytics grew by more than 20%, social by more than 40%, and mobile by a factor of four. IBM's mobile partnership with Apple is no doubt responsible for a large portion of this growth. In 2014, mobile was already a $1 billion business for IBM.
IBM's cloud revenue grew by 75% year over year during the first quarter, with the trailing-12-month total reaching $7.7 billion. This includes hardware, software, and services, so it isn't directly comparable to cloud revenue from companies such as Amazon.com. However, the growth rate is impressive nonetheless.
Investors should expect continued rapid growth in these areas during the second quarter. During the first quarter, IBM's strategic imperatives as a whole grew by 30%, faster than the 20% growth rate during 2014. Growing a $25 billion business at a 30% rate is certainly nothing to sneeze at, and while declining revenue in other parts of the business will balance out this growth, IBM is making serious progress.
Investors should also pay attention to IBM's margins. The company's strategic imperatives are more software-heavy than the rest of the business, and with software being the most profitable part of IBM's business, IBM is capable of growing profits faster than it grows revenue.
During the first quarter, IBM's pre-tax margin increased 2.7 percentage points year over year to 18.4%. While margins in the services business declined slightly, an increase in software margins, along with the new mainframe boosting hardware margins, led to the overall increase.
Mainframe sales should remain strong relative to the same period last year during the second quarter, boosting margins in the process. However, this boost will begin to wane in future quarters, as mainframe sales tend to spike when new models are released.
IBM's results are going to be noisy, with currency effects and divestitures likely to cause a big gap between reported and adjusted numbers. But IBM's long-term plan, growing its strategic imperatives while maintaining profitability in its core businesses, appears to be going well, and investors should look for more signs of progress during the second quarter.