International Business Machines Corp. rode the success of old technology to big gains at the end of last year, but investors will be looking for success from newer businesses in order to believe in Big Blue’s future.
IBM IBM, -0.86% is scheduled to report earnings on Tuesday after the close of markets. Key points will be the potential impact of China tariffs and the company’s gross margins. Most important might be the company’s services revenue, which is far behind systems revenue growth despite comprising newer efforts.
Compared with the year-ago quarter, analysts expect technology services and cloud-platform revenue to rise 0.8% to $8.28 billion and cognitive-solutions revenue to rise 3.8% to $4.22 billion. These are IBM’s newer business areas where investors would like to see stronger growth Technology services and cloud-platform includes IBM Cloud, formerly known as Bluemix, while cognitive solutions includes IBM’s Watson AI.
Other business areas include global business services, where analysts expect revenue to rise 1.1% to $4.05 billion, and systems revenue, where analysts expect revenue to rise 23% to $1.72 billion from the year-ago period. Global business services includes consulting for modernizing business design and enterprise and cloud applications, while the systems business includes operating-systems software and the company’s mainframe business including IBM’s z14 line of servers.
It was a mainframe refresh that helped IBM break a streak of nearly six straight years of revenue declines in the most recent quarterly report. Investors hope the newest one will show that newer technologies can grow at a similar rate.
What to expect
Earnings: Of the 19 analysts surveyed by FactSet, IBM on average is expected to post adjusted earnings of $2.41 a share, up from the $2.30 a share expected at the beginning of the quarter. Estimize, a software platform that uses crowdsourcing from hedge-fund executives, brokerages, buy-side analysts and others, calls for earnings of $2.41 a share.
Revenue: Wall Street expects revenue of $18.84 billion from IBM, according to 16 analysts polled by FactSet. That’s up from the $18.37 billion forecast at the beginning of the quarter. Estimize expects revenue of $18.73 billion.
Stock movement: IBM shares are down 7% from the company’s previous earnings report in January, compared with a 5.9% decline in the Dow Jones Industrial Average DJIA, -0.50% over the same period. IBM shares, however, are still up 2.4% for the year, unlike the Dow, which counts IBM as a component and is down 1.2%.
What analysts are saying
RBC Capital Markets analyst Amit Daryanani, who has an outperform rating and a $180 price target on IBM, said investors will be looking for improved gross margins as well as any potential impact from China tariffs.
“Given an improved IT spend backdrop combined with favorable f/x environment, we think IBM should report slight upside to both revenue and EPS results vs. consensus,” Daryanani said in a recent note. “We see high probability gross margins are up (not just “stable”) in H1:18, which should enable IBM to work higher from current levels.”
IBM gross margins for the year-ago March-ending quarter were 42.8%, and 48.2% for the most recent December-ending quarter.
Stifel analyst David Grossman, who has a buy rating and a $182 price target, expects IBM results to be largely in-line on the back of the mainframe cycle in systems revenue and cognitive solutions sales.
Grossman said “ the cornerstone of our positive investment thesis is that IBM’s services unit begins to improve in 2H18 with a return to growth sometime in 2019,” adding:
Services represent 63% of IBM’s revenue and have been declining 2-3% (~2% headwind to consolidated growth in 2017). Systems (10% of revenue), on the other hand, has been contributing 2-3% to IBM’s growth rate the past six months with the shipment of a new mainframe product.
Wedbush analyst Moshe Katri, who has a neutral rating and a $185 price target, said the company will still face headwinds in services and software businesses.
“We believe results at IBM’s IT Services segments have been impacted by a combination of model delivery shift changes as well as pricing/margin compression due to large contract re-compete exposure,” Katri said.
Of the 24 analysts who cover IBM, eight have buy or overweight ratings, 14 have hold ratings and two have sell or underweight ratings, with an average price target of $169.79, about 8% higher than current prices.