IBM Earnings Present Cloudy Outlook

IBM-earningsInternational Business Machines (NYSE: IBM) unveiled first-quarter earnings that topped analyst expectations on earnings, but missed on revenue. This is a trend throughout corporate earnings this quarter. Multinational corporations, such as those that comprise the Dow Jones Industrial Average, are seeing revenue decline significantly due to currency movements.

Global firms are suffering from the strong U.S. dollar. Over the past year, the dollar’s value rose dramatically against other currencies, including the euro, which is a big problem for large multinational companies like IBM.

The strengthening dollar makes international sales worth less when that revenue is converted back into the domestic currency. This also makes for difficult year-over-year comparisons, since earnings last year were not significantly affected by currency.

Still, many companies are able to counteract currency effects with significant cost cuts, and IBM was no exception. Lower expenses, as well as strong performance in its key strategic growth areas, helped the company beat expectations.

Revenue Woes

The first-quarter IBM earnings report reveals that it has had a very tough time growing revenue. The company remains highly reliant on old areas of technology, like hardware, which aren’t growing. Systems and technology revenue fell 23% year-over-year, although excluding divested businesses and currency, it actually increased 30%. This is an important reminder that IBM has sold off or otherwise divested several underperforming businesses in recent years.

For example, last year IBM sold its x86 server business to Lenovo (OTC: LNVGY) for $2.1 billion. It also sold its semiconductor business to chip maker GlobalFoundries. In all, IBM rid itself of business operations that generated $7 billion in annual revenue but produced $500 million in pretax losses. The business sold to Lenovo generated $4 billion in revenue in 2013 but no profit.

These were the right decisions, which will allow IBM to focus its future investment on higher-growth, higher-margin businesses in exciting new areas like the cloud, Big Data and mobile. It’s hard to see the effects just yet, because these businesses are still in their early stages and still represent a relatively small part of the overall company.

On the whole, total revenue was flat year-over-year when adjusted for currency and divestitures. Operating earnings grew 9%, to $2.91 per share. Again, hardware was the problem.

Sunny Forecast for Cloud Computing

IBM’s key growth drivers continue to be its “Strategic Imperatives,” which include higher-growth areas like the cloud and analytics. Collectively, these categories grew revenue by more than 30% when adjusted for currency and divestments.

Cloud revenue soared more than 75% last quarter. For cloud delivered as a service, revenue reached a $3.8 billion annual run rate, up from a $2.3 billion run rate at the same point last year. And business analytics revenue rose more than 20%.

This growth, should it continue, will eventually allow IBM to return to overall revenue growth. In the meantime, the company remains highly profitable, which helps it continue rewarding shareholders even though revenue isn’t growing.

Long-Term Outlook

Despite its top-line struggles, IBM still generated more than $1 billion of free cash flow just last quarter. With this, it returns a great deal of cash to shareholders. The stock offers a solid 2.7% dividend yield. It’s also due to increase its dividend at the end of this month, which means investors are about to get even more cash in their pockets.

IBM clearly is in a difficult turnaround phase. This makes it hard to consider it as a growth stock. However, the stock does offer compelling value, trading at just 13 times earnings. Along with its high dividend yield, IBM is a stock with something to offer both value and income investors.

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Published by Wyatt Investment Research at