Shares of the narrow-moat firm remain fairly valued, and we would seek a wider margin of safety before investing.
By Andrew Lange | 04-19-17 | 01:22 AM | Email Article

The story stayed the same during  IBM’s first-quarter results, with the firm continuing its ongoing shift to higher-growth and higher-margin strategic imperatives. For the quarter, strategic imperatives grew 13% year over year to $7.8 billion, with notable cloud revenue growth of 35% driving the result. Still, headwinds in legacy areas remain a growth drag and are expected to be a burden as IBM strives to generate positive medium-term group revenue growth.

Andrew Lange is an equity analyst for Morningstar.

We were surprised by the decline in gross margins during the quarter; however, management described the challenge as temporary, as it reflects IBM’s high degree of reinvestment and business mix to as-a-service, which we largely agree with.

We forecast modest top-line revenue growth for IBM from fiscal 2018 onward as strategic imperatives grow in magnitude (now constitute 42% of revenue on a trailing 12-month basis), and we believe other endeavors surrounding workforce alignment, services signings, and new products should help with this revenue goal. For fiscal 2017, management’s outlook is unchanged, and we reiterate our $158 fair value estimate and narrow moat rating. With the firm trading down afterhours and remaining close to our fair value estimate, we would seek a wider margin of safety before investing.

For the quarter, reported revenue decreased 3% to $18.2 billion (fell 2% in constant-currency terms). Currency was again a headwind, but more importantly, macroeconomic and geopolitical factors hindered performances in Europe, the Middle East, and Africa, or EMEA, with the U.K. and Germany seeing particular pressure. In terms of business segments, cognitive solutions saw decent solutions software growth as analytics, Watson, and security led the way. IBM remains committed to Watson, and partnership momentum for health, the Internet of Things, and financial services supports IBM’s long-term investments in this area, although the long-term economics and returns of these Watson businesses remains ambiguous.

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