Markets have been on a wild ride in 2022. Tech has been burned as investors move out of growth names. However, there is one tech name that provides an opportunity in this environment.
International Business Machine (IBM) posted its Q4 earnings Monday night. The results were encouraging, and the company’s free cash flow and revenue acceleration should protect its dividend yield which is why we are looking at the name.
Lets take a closer look at the Q4 results.
IBM continues to transform itself into a software giant, shedding its slower growth hardware business. The company’s M&A strategy remains front and center as it made 15 acquisitions in 2022, 5 in Q4 alone.
This quarter is the first view of IBM since the post-separation from its managed IT services business, Kyndrel (KN).
IBM posted revenue growth of 6.5%, its best number in a decade. The $16.7 billion figure outpaced Wall Street expectations of $16.1 billion. The company maintains a close relationship with KN and the spin off helped drive revenue growth by approximately 3.5 points.
Better results were driven by strength in its cloud business which increased 16% y/y to $6.2 billion (37% of revenue). Red Hat revenue all in was up 21%. Hybrid cloud revenue grew 34% in the quarter. For the year, cloud revenue is up 32% to $8 billion. The higher value business mix as software and services now represent 70% of sales. The software business has significantly increased as part of its recurring revenue stream.
This supports the bull argument that CEO Arvind Krishna’s strategy for growth is starting to pay dividends.
The fourth quarter results gave IBM the confidence to project mid-single digit (MSD) revenue growth for 2022. This is a reiteration of IBM’s previous forecast of MSD from 2022-24. The 2022 guidance does not include a boost from KN.
IBM guided 2022 free cash flow in the range of $10.0-10.5 billion. It reiterated its medium-term outlook of generating $35 billion in FCF by 2024. The FCF improvement is driven by lower payments for the structural actions, a modest tailwind from cash taxes, working capital improvements and profit growth from its higher value business mix.
Analysts did raise some concern around the FCF outlook. On the earnings conference call. One analyst noted that the revenue and margin projections would seem to yield net income below the company’s free cash flow guide.
IBM stated that it would not provide EPS guidance as ‘there are many ways of getting to an EPS number’. The company prefers to provide revenue and FCF projections.
Questions around the FCF outlook and lack of EPS direction were the reason why we saw shares slip from $136 to $131 during the call. This will remain a key metric to watch around earnings.
The company’s commentary around enterprise spend was encouraging for tech. IBM sees a strong environment for customer spend. They are not seeing any disruption from omicron on their business. This strengthens the story that the global economy is facing supply issues, not demand. We would scrutinize the selloff in Salesforce.com (CRM) based on this commentary.
Companies with high debt are worrisome in a raising rate environment. It is encouraging to see IBM lower its debt by $9.6 billion to $51.7 billion. IBM’s debt is down $21 billion since it acquired Red Hat.
The transition story is flying under the radar. We have seen software names hammered due to the high valuations, but this stock is cheap, trading at forward earnings of 12.5x. Price to sales is only 1.5x. It trades at a free cash flow of 14x compared to 20x for Oracle (ORCL).
Perhaps the most interesting aspect of IBM is the handsome dividend yield at 5.09%. That is very nice income to collect in a choppy market.
Old tech was brushed aside the past few years. This is evident in the IBM monthly chart as it has chopped around the $100-140 area since 2019. The transition of the company from a hardware to software tech giant has created these headwinds but we are starting to see the strategy boost top and bottom-line results.
We would put this name on your shopping list as it stands ready to push forward under its new umbrella and investors can collect some nice income while market volatility persists.
