So, IBM reported the other day, and got taken down some more. “How long you gonna hold that pig,” a reader wants to know? My answer is… probably for a very long time, here’s what I read about that ‘loser,’ from someone who’s analysis I highly respect:
“IBM released its second-quarter results late yesterday afternoon. Reading the financial media’s coverage of the results felt a little like reading its obituary.
“IBM’s Sales Slump Extends to 13 Quarters“, said the Wall Street Journal, making a big deal out of a trend everyone covering the stock already expected. Remember, IBM is shedding less profitable hardware businesses (like System X) and investing heavily in five faster-growing “strategic imperatives”: data, cloud, social, mobile, and security.
Yes, total revenues from continuing operations for the second quarter of $20.8 billion were down 13% year over year. That does sound worthy of the WSJ headline. However, when adjusting for exchange-rate fluctuations and divestitures, revenues declined just 1%. Since 60% of IBM’s revenue, earnings, and cash flow are generated in foreign currencies, they translate into lower amounts when the U.S. dollar is strengthening, as it has been this year.
Revenue in “BRIC” countries (Brazil, Russia, India, and China) was particularly weak in the second quarter. Brazil and Russia are commodity-oriented economies that are heavily dependent on oil. And oil is down some 50% over the past 12 months.
Management says excluding the BRICs, revenue for the quarter would actually have increased 1%. In developed markets, total revenue growth was down slightly in the U.S. but up in two of IBM’s largest countries: Germany and Japan.
Importantly, the transition to faster-growing revenue sources appears to be on track. IBM’s analytics business (think artificial intelligence learning machine “Watson”) – which helps customers make sense of the huge amount of data they’re now collecting – grew 20% over the first half of 2015.
That’s impressive growth for a business that generated $17 billion in revenue during 2014 and is larger than Facebook, which recorded about $12.5 billion in revenue last year.
Revenue growth for cloud services was also up a strong 70% year-over-year. At $8.7 billion in revenue over the last 12 months, IBM’s cloud unit is about 75% larger than Amazon’s web services cloud platform, which CEO Jeff Bezos recently characterized as being a $5 billion business.
IBM continues to invest heavily in its aforementioned strategic imperatives, like the cloud. For example, IBM now operates 41 cloud data centers on five continents. However, as these businesses continue to grow and eventually reach their optimum scale, the level of required investment will decrease and profitability will rise.
Most investors can’t see this because they’re obsessing over a 1% quarterly revenue miss. They’re also overlooking the fact that free cash flow actually increased 10% year over year for the first half of 2015, despite a 13% drop in revenue. Meanwhile, the company will continue using it to reduce the share count and pay a healthy, growing dividend.
IBM is generating 50% returns on equity even while executing a major business transformation – one of many successful transitions throughout its 100-plus-year history.
It’s gushing $12 billion a year in free cash flow. It’s investing heavily in the best business on the planet in terms of returns on invested capital: software.
It’s the No. 2 software company in the world today, after Microsoft. IBM has generated more patents (mostly software-related) every year than any organization in the world for the last 21 years. It’s creating huge new billion-dollar businesses (like Microsoft was years ago when everyone was bashing it and we were urging readers to buy it in the low $20s).
I don’t know exactly what IBM will look like in five to 10 years, but I’m confident its new, higher-margin, software-based businesses will be larger and more profitable. I also believe its share count will be much lower. That alone should push the share price higher.
Our advice remains the same…
BUY IBM (NYSE: IBM). Right now, shares trade around $163.” All italic emphasis was mine.
I’m likely to buy more of this ‘pig’ and build a larger position in this ‘loser’ for some time to come, then, in some years from now, as its transition comes closer to completion and its efforts begin to come to fuller fruition… I’ll own a lot of one of the very safest-dividend growers on planet earth. What I will be looking for, is to see if analysts begin revising their estimates at all, either higher or lower. I should begin to see that in the numbers within the next couple of weeks, and I will tell you what they are doing. Even now, Big Blue remains on of the most shareholder friendly companies I am able to find. It’s all about the safe-dividend growth, friends! If you don’t like IBM… don’t buy any.
Here’s to your successful investing!
Harold F Crowell