Shares of International Business Machines (IBM - Free IBM Stock Report)fell rather sharply after the global supplier of computer hardware, software, and services, and Dow-30 component, reported earnings that matched expectations on very disappointing revenues.
For the opening quarter of 2014, IBM reported earnings of $2.29 a share after $0.25 of acquisitions/retirement costs, compared with our estimate of $2.20 a share, and $2.70 in the 2013 March period. Results also included a $0.67-a-share workforce rebalancing charge, partly offset by a $0.07 gain on the divestiture of a business.
Revenues, which declined for the eighth consecutive quarter, were the problem, falling 4% as reported, 2% on a constant-currency basis, and 1% excluding the effect of currency (the impact of the Japanese yen and Venezuelan devaluation) and the divestiture. On a geographic basis, revenues in major markets, like the United States, slipped 1% adjusted for currency, but developing nation markets fell 5%, with China down 20%. The top line was also dragged down by a 24% decrease in systems revenues. The weakness was spread across IBM's systems lines. System z mainframe servers fell 40%, reflecting a winding down of the product cycle; Power systems were down 22%; System x servers declined 18%; Storage servers fell 23%. Apparently, more customers are purchasing computer power as a service rather than running their own systems in-house. Systems profits declined 35% from the year-earlier quarter.
IBM's services business turned in a lackluster performance, with technology services revenues down 3%, but up 2% excluding currency and the divestiture, and business service revenues flat on a reported basis, but up 2% excluding currency. Gross margins in both parts of the services segment expanded a bit more than a percentage point, though pretax margins contracted owing to the workforce rebalancing costs.
The software segment was the only bright spot, with revenues up 2%, boosted by a 5% increase in key branded middleware. Software gross margins, which are significantly wider than for servers and services, expanded slightly, helping to boost the consolidated gross margin. But in tandem with its server and services segments, software pretax margins narrowed.
Looking ahead, management is taking actions to address the weakness in the mainframe computer business. IBM has announced the sale of its industry-standard server business to Chinese computer giant Lenovo, which purchased its personal computer business back in 2005. It is taking measures to right-size its power systems and storage systems operations. It is beefing up investments in newer technologies, like analytics. These initiatives probably will take time to pay off, but IBM expects the workforce rebalancing actions to pay back within a year. IBM also expects it to take some time for revenues in China to improve, but over the long haul, its efforts to build up its businesses in developing nations should eventually support stronger revenue growth.
The company is maintaining its share-net goals, excluding about $1.00 of acquisitions/retirement costs, of $18.00 in 2014 ($17.00 including these costs) and $20.00 in 2015. Although IBM had a good track record on meeting its earnings targets in the past, it will have to push very hard to reach the $20.00 mark in 2015. We are cautious, and look for reported results (including the $1.00 a share of acquisitions/retirement costs) of $16.80 a share in 2014, a bit short of the $17.00 target. For 2015, we are introducing an earnings estimate of $18.50.
The high-quality stock has long been viewed as a core holding for conservative investors, and the issue's sharp pullback following the earnings release enhances its 3- to 5-year potential. But long-term investors in IBM shares probably will need to be very patient.
About The Company: International Business Machines is a worldwide supplier of advanced information processing technology, communication systems, services, and program products. Revenues in 2013 can be broken down as follows: Global Technology Services, 37%; Global Business Services, 18%; Systems and Technology, 14%; Software, 27%; Global Financing, 4%. Foreign business accounted for 65% of 2013 revenues.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.