EUR 850.00 For Business Accounts Only

Morningstar | IBM Posts Constant Currency Growth; Systems Business Provides Healthy Boost; Shares in 3-Star Range

IBM's second-quarter result marked an improvement in the company's underlying growth rate with management touting that its constant currency growth rate of 2% year over year was the best in seven years. However, in what's become commonplace, the firm's balancing act between higher growth strategic and low-to-declining nonstrategic imperatives continues to overhang the company, which is expected to keep the firm's top line suppressed over the midterm. The performance of the systems business (which is benefiting from the recent release of the z14 mainframe product line) certainly bolstered IBM's quarterly result, but we expect the cyclicality of this business to provide only a periodic boost given traditional mainframe refresh cycles. Over the midterm, one green shoot we are more focused on is IBM's services businesses, which encapsulates both global business services, or GBS, and technology services & cloud platforms, or TS&CP. In what has been a long-term struggle, both businesses posted year-over-year growth (albeit very modest). Still, we think IBM's world class services organization continues to have an important role in providing digital transformation services, particularly around hybrid cloud management and managed security services. If IBM can successfully reinvigorate these services businesses and generate more industry-like growth, we would become more bullish on the name (we'll monitor services signings and cloud-related growth in the interim). Nevertheless, with management reiterating it full-year outlook and our view unchanged, we are maintaining our $168 fair value estimate and narrow economic moat rating. With shares approaching 3-star territory in after-hours trade, we think the firm is only modestly undervalued, although it may appeal to dividend seeking technology investors.

For the quarter, revenue rose 4% year over year to $20.0 billion (increased 2% in constant currency). On a constant currency basis, cognitive solutions revenue fell 1% to $4.6 billion, GBS and TS&CP were flat at $4.2 billion and $8.6 billion, respectively, systems surged 23% to $2.2 billion, and global financing dipped 6% to $394 million. IBM's all-important strategic imperatives grew 13% year over year in constant currency and constituted 48% of the firm's trailing 12-month revenue (up from 47% in the prior quarter). While the strategic imperative business continues to grow and will eventually become the majority of revenue, we do expect a gradual slowdown in the growth trajectory which is already being realized. Nevertheless, we think it is the right direction for the company if it is to achieve even modest midterm revenue growth, and as such, we see the relevancy of IBM's cloud and security businesses as being key parts of this future direction.

IBM's pretax margin improved to 13.9% from 12.7% in the year ago period. The margin performance was driven by both operating leverage from top line growth and a focus by management on productivity and spending, despite some necessary investments. We expect the firm's ongoing productivity focus to benefit the company in the second half of the fiscal year too and forecast a full-year pretax margin in the 15% range.