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IBM share price rallies on strong Q4: Where next?

IBM’s Cloud and Cognitive arm outdid all other segments to become the top revenue performer of FY2019, a trend that should make Wall Street bulls very happy.

Source: Bloomberg

US computer hardware and service company IBM Corporation (NYSE: IBM) share price rallied over five percent in after hours trading on Tuesday (21 January), after beating analysts’ estimates in its Q4 2019 financial result.

Better-than-expected Q4

The company recorded non-GAAP earnings of US$4.71 per share (EPS), versus a forecast of US$4.69 per share on Refinitiv.

In revenue, IBM made US$21.77 billion, also beating Refinitiv analysts’ earlier estimate of US$21.64 billion.

Across the full 2019 fiscal year, non-GAAP EPS was US$12.81 on total revenue of US$77.1 billion, a decline of 3.1% year-over-year.

‘We ended 2019 on a strong note, returning to overall revenue growth in the quarter, led by accelerated cloud performance,’ said Ginni Rometty, IBM chairman, president and chief executive officer.

Performance by business segment

Undoubtedly, the company’s star performer in Q4 – and across the full year – was the Cloud and Cognitive Software segment, which includes Cloud and Data Platforms like the newly-acquired Red Hat; Cognitive Applications; and Transaction Processing Platforms, with revenues up 8.7% year-on-year to US$7.2 billion.

Red Hat, which IBM acquired in July 2019 for US$34 billion, was able to turn in a Q4 revenue of US$573 million, down year-on-year from US$863 million pre-acquisition.

Notably, this marks the first quarter that Cloud and Cognitive Software has brought in the most revenue out of all the segments. Across the whole of 2019, the segment also recorded a total revenue of US$23.2 billion, up from US$22.21 billion in 2018.

Comparatively, overall company revenue for 2019 is down three percent to US$77.15 billion from US$79.6 billion the year prior.

Global Technology Services, the pillar for Infrastructure and Cloud Services and Technology Support Services, contributed the next biggest share, with revenues of US$6.9 billion, although this is down 4.8% year-on-year.

Most improved is Systems, which includes Systems Hardware and Operating Systems Software led by the IBM Z, with revenues of US$3.0 billion, up 16% from Q4 2018.

Meanwhile, Global Business Services, which overlooks Consulting, Application Management and Global Process Services is down slightly by 0.6% with revenues of US$4.2 billion. Holding the segment afloat was the Consulting arm, which grew four percent.

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Official outlook for 2020

With the cloud segment growing rapidly, IBM has provided a guidance of an operating non-GAAP EPS of at least US$13.35, a slight increase from the actualised FY2019 earnings. The company also expects a free cash flow of approximately US$12.5 billion, which would be a five percent increase from 2019’s free cash flow of US$11.9 billion.

Rometty also said: ‘Looking ahead, this positions us for sustained revenue growth in 2020 as we continue to help our clients shift their mission-critical workloads to the hybrid cloud and scale their efforts to become a cognitive enterprise.’

Looking much further ahead, the company also expects Red Hat to contribute approximately two points of compound annual revenue growth to IBM over a five-year period.

What's the call on share price?

IBM’s share price is up nearly four percent since the start of the year, and is currently trading at a three-month high of US$139.17.

So far, January 2020 is already proving to be better than the last three months of 2019, which saw share price stuck around the US$132 to US$136 region.

Much of that late-year sluggishness had taken place following a not-so-great third quarter, which saw revenues fall 3.9% year-on-year.

But with cloud revenues growing and research analysts enthusiastic about the Red Hat merger, Wall Street bulls are feeling more optimistic than ever.

Over the next five years, the International Data Corporation (IDC) expects enterprises to invest heavily in the cloud. A large and increasing portion of this investment will be on open hybrid and multicloud environments that enable them to move information across different environments. As Frank Gens, Senior Vice President and Chief Analyst, IDC, says IBM (with Red Hat on board) is ‘well positioned’ to capitalise on this trend.

One of those bulls – Instinet analyst Jeffrey Kvaal, who has a ‘buy’ rating and a US$170 price target, believes ‘investors should focus on IBM’s EPS potential in 2021, which we forecast ~9% growth to $14.60; consensus models ~$14.30’.

He adds that the company’s key earning drivers are the RedHat accretion, continued growth in core IBM, and lower interest expense as debt levels improve.

Evercore ISI analyst Amit Daryanani, however, recently downgraded IBM’s stock outlook to ‘in-line’ from ‘outperform’, and price target to US$145 per share from US$160 on the back of a bleak business outlook for the first half of 2020.

IBM currently has an overall ‘hold’ rating from 13 out of 20 analysts, with an average price target of US$148.53.

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