IBM: Big Blue In Deep Red After Disappointing Quarter Earnings

IBM Common Stock

The company formerly known as “Big Blue,” International Business Machines (NYSE:IBM), has seen better days. Over the last decade, the once-adored tech darling has struggled to outperform 30-year Treasury bonds, behind the Invesco QQQ Trust (NASDAQ:QQQ) by 385%. It hasn’t been for a lack of effort. IBM (NYSE:IBM) has undoubtedly attempted the buyback method. It also attempted to purchase “growth.” While nothing has worked in the last decade, IBM recently reversed a troubling metric.

This appeared to be an excellent report at first sight. Revenues increased by 9% to $15.5 billion, or 16%, when currency effects were excluded. All segments gained well, with infrastructure income increasing by a whopping 25% on a constant currency basis. IBM (NYSE:IBM) outperformed expectations on both the top and bottom lines, earning $2.31 per share in non-GAAP earnings. After hours, the stock was down by more than 4%. What happened? Sometimes reactions are just reactions, in which participants sell because they have made up their minds to do so. In the case of IBM, there were a few difficulties that investors could cite to justify a lower price.

First, IBM is a US corporation, and profits are measured in US dollars. Constant currency measures indicate the robustness of the underlying business, but the net figure that matters is the one in USD. The difference between actual and continuous currency amounts this quarter was fairly large. Some of this may have been expected by investors, but there are timing concerns with when cash arrives and earnings are booked. As a result, the spread most certainly caused some surprise.

IBM Revenue Growth

Revenue growth: The company expects constant currency revenue growth in the high single digits. Currency is predicted to be a six-point headwind at mid-July 2022 foreign exchange rates. In addition, the firm anticipates an additional 3.5-point contribution from incremental sales to Kyndryl.

Free Cash Flow: The company expects consolidated free cash flow of $10 billion to $10.5 billion.

We believe investors are mainly concerned with the growing currency headwind and the decline in free cash flow. Another thing we found was that gross margins fell dramatically in two of the three primary segments (financing is a minor segment). Wages have risen significantly across the board, with the Atlanta Fed Wage Tracker showing an increase of 6.2% year on year. This is likely not over, and we may expect more compression in the future.

The US currency is the first and most crucial cyclical headwind here. It reduces sales directly and makes it more difficult for US companies to compete with European and Asian peers. Based on the strength of the US dollar, we believe that profit revisions have just begun to price it all in. IBM (NYSE:IBM) will undoubtedly be harmed due to its global presence. The second factor to consider is the global economic downturn caused by rising interest rates and higher inflation. The impending fiscal cliff in the United States will exacerbate the situation. We can tell you without going into detail that it will not be pleasant.

Finally, we believe technology will bear a disproportionate share of the downturn because it gained the most from the 2021 optimism. One indicator of how terrible things will go is the rapid accumulation of semiconductor chips.

Of course, all of this may be priced so you can make a compelling case for purchasing. We don’t believe it has been priced in on that front. Yes, if you utilize consensus earnings forecasts and non-GAAP earnings, it seems fine at 13X 2023 earnings. We believe those are unduly optimistic and that revenues and profits will fall short. The price-to-sales ratio is our preferred indicator for IBM since it removes the nonsense of non-GAAP influences. We don’t think IBM is inexpensive based on this. To have a decent possibility of making money, you should acquire something below 1.5X sales.

Big Blue was in the negative in the after-hours of trading today. That could change tomorrow, but we’d be wary about forming a bullish case. Yes, IBM is reversing its sales declines, despite an extremely strong US dollar. That’s great. However, we believe valuation is relatively high at this point in the business cycle. Analysts are always optimistic, remembering that they predicted nearly $15.00 in earnings for 2022 at the start of 2020. We’re presently under $10.00.

Featured Image: DepositPhotos © Aprescindere

Please See Disclaimer

About the author: Adewumi is an expert financial writer and crypto enthusiast with more than 2 years' experience in writing crypto news and investment analysis. When not writing or reading about crypto and finance, Adewumi spends his time watching football and visiting museums and art galleries.