International Business Machines Corp. 2016 Guidance Fails to Rally Investors

IBM (IBM -8.25%) reported fourth-quarter results on Tuesday night. Investors apparently looked past results firmly in line with management guidance to focus on a disappointing forecast for the next fiscal year. IBM shares fell more than 4% in after-hours trading.

IBM results: The raw numbers

Source: Yahoo! Finance.

What happened with IBM this quarter?
This was another mixed bag, as IBM struggles to fully embrace a leaner and lighter business model.

• IBM's so-called strategic imperatives is an umbrella term for high-growth products in cloud computing, data analysis, and user engagement. That block delivered 10% revenue growth from the year-ago quarter, or 16% in constant-currency terms. Strategic imperatives now account for 35% of Big Blue's total annual sales, up from 27% in 2014.
• Three months ago, management set up fourth-quarter earnings guidance between $4.66 and $5.66 per share on an adjusted basis. Actual adjusted results came in at $4.84 per share, near the bottom of the guidance range. However, that guidance range included typical seasonal patterns, and IBM CFO Martin Schroeter was always "comfortable" at the lower end.
• Adjusting the fourth-quarter results for currency exchange effects, total sales would have fallen 2% year over year. From that perspective, sales would have increased 1% in the Europe, Africa, and Middle East region while still falling 3%-4% in the rest of the world.
• From a product perspective, the z Systems mainframe lineup saw constant currency sales rising 21%. Technology services also delivered positive growth while both software and business services declined.

IBM will continue to battle serious currency headwinds in 2016, throwing shadows over the new fiscal year.

• Currency effects reduced 2015 sales by 8%. Early 2016 trends point to a smaller currency effect this year, but cash flow hedges that were set up to handle these issues are starting to roll over on the calendar. Thus, the bottom-line impact from another year of rising dollar values could do a disproportional amount of damage to IBM's earnings.
• Adjusted full-year earnings are expected to land at "at least $13.50" per share. This forecast includes about $1.00 per share of currency-related damage, and would be a slight decrease from 2015's $13.60 bottom-line performance.

Growth rates in constant-currency terms, excluding divested businesses. Source: IBM.

What management had to say
CEO Ginni Rometty highlighted the rising stature of IBM's strategic imperatives, describing this shift as a "transformation to higher value." In a press statement, Rometty painted a rosy picture of IBM's most important growth drivers: "We strengthened our existing portfolio while investing aggressively in new opportunities like Watson Health, Watson Internet of Things, and hybrid cloud. As we transform to a cognitive solutions and cloud platform company, we are well positioned to continue delivering greater value to our clients and returning capital to our shareholders."

Looking ahead
This is the turnaround story that never seems to end. Rometty's vision of strong growth under the strategic imperatives banner is marred by weak support from the remainder of Big Blue. The strong mainframe systems sales in recent quarters are not sustainable, but an aberration based on a revamped product line. Remember that GAAP sales of z System mainframes rose 20% in the third quarter (without adjusting for currency) and fell back to a 16% clip in the fourth quarter.

IBM shares have now fallen more than 20% over the past 52 weeks, or 30% in two years. The stock trades at a rock-bottom 8.9 times trailing earnings, and IBM's dividend yield has been pushed up to a generous 4.1%.

Many investors are losing patience with this painful strategic makeover. Unfortunately, management's earnings guidance for the 2016 fiscal year wasn't exactly steeped in rainbows and roses, so patience continues to be an uncomfortable virtue for IBM shareholders.