Thursday, October 28, 2021

IBM – Attractive Growth, Unattractive Valuation

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(C) Reuters. IBM – Attractive Growth, Unattractive Valuation

I am neutral on International Business Machines Corporation (NYSE:IBM), because – while its dividend yield and cash flow stability are attractive – the business’ weak growth prospects mean that its valuation is not particularly attractive at the moment.

International Business Machines Corporation is a global leader in computer hardware and software and has offered business innovation through an open cloud platform and artificial intelligence around the world since 1911.

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IBM ‘s Strengths

IBM has an extremely strong brand legacy and offers a diverse range of core offerings, including cloud computing, computer software, hardware, and artificial intelligence in over 170 countries. It employs more than 300,000 people in the world and has a combined revenue of over $70 billion. Strategic acquisition and mergers with computing, technology, AI, and consulting companies have strengthened IBM’s position in the global competitive market, and it is regularly recognized as one of the best brands in the world.

IBM’s Recent Results

In its second quarterly 2021 report, IBM announced revenue of $18.75 billion, beating analysts’ expectations of $18.29 billion. Its earnings per share were $2.33 vs. an expected EPS of $2.29. The company’s revenue grew by 3% year-over-year in Q2 2021, the fastest growth in the past three years, and the company expects it to keep growing for the remainder of the year.

Its Cloud and Cognitive Software business, which includes IBM’s acquisition of Red Hat, contributed $6.10 billion in revenue, up 6% more than consensus estimates of $5.93 billion. Its Global Business Services unit added $4.3 billion in revenue, resulting in a growth of almost 12%. Systems revenue amounted to $1.71 billion, which saw a decrease of 7%.

In the second quarter of 2021, IBM spent $1.75 billion on acquisitions, the highest amount it has spent in a single quarter since it closed the $34 billion deal with Red Hat in Q3 2019. The company stated it was acquiring myInvenio, a process-mining software company; Turbonomic, an application-management company; and Waeg, a Salesforce (NYSE:CRM) consulting company.

IBM also announced a 2-nanometer chip technology and new AI features for its Watson Studio software.

Following its better-than-expected results, shares of IBM increased by 4%. The company did not provide formal guidance; however, management continues to expect revenue to grow throughout the year. It also expects an adjusted free cash flow in the range of $11 billion to $12 billion for the fiscal year 2021.

Valuation Metrics

IBM’s stock looks reasonably valued right now, as its EV/EBITDA ratio and Price to Normalized Earnings ratio both indicate the stock is trading close to its historical range. The EV/EBITDA ratio is currently 9.24x, compared to its 5-year average of 8.94x. The Price to Normalized Earnings ratio is currently 12.40x, compared to its 5-year average of 11.03x. (See IBM stock charts on TipRanks)

Wall Street’s Take

From Wall Street analysts, IBM earns a Moderate Buy analyst consensus, based on 4 Buy ratings, 6 Hold ratings, and 0 Sell ratings in the past 3 months. Additionally, the average IBM price target of $158.20 puts the upside potential at 10.46%.

Summary and Conclusions

IBM is a global information technology giant with a strong moat around its current earnings stream. However, the business has struggled to grow for an extended period of time and there remain concerns about its competitive positioning in its growth businesses against tech giants like Microsoft (NASDAQ:MSFT), Oracle (NYSE:ORCL), Google (NASDAQ:GOOGL), and Amazon (NASDAQ:AMZN).

That said, the price is not necessarily expensive – though it isn’t particularly cheap either – so I think investors might want to wait for a pullback before initiating a position.

Disclosure: At the time of publication, Samuel Smith did not have a position in any of the securities mentioned in this article.

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