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Stock Analysis - International Business Machines (IBM)

Initial Screening

International Business Machines Corporation, or IBM, has been a blue-chip company in the tech sector for decades. Founded in 1911, IBM has been in the top 10 largest companies by market cap several times over the last 100+ years.

Its peer group consists of Microsoft Corporation (Nasdaq: MSFT), Oracle Corporation (NYSE: ORCL), and Intel Corporation (Nasdaq: INTC) which are no strangers to dividend and tech investors.

Though all financial figures quoted throughout this article will be referenced in USD, IBM is listed on multiple exchanges including the New York Stock Exchange (NYSE: IBM), the London Stock Exchange (LON: IBM), and the Frankfurt Stock Exchange (FRA: IBM).

IBM infographic

Business Model

Though considered a backbone in operating infrastructures for supply chains and financial institutes worldwide, the Americas account for 47% of IBM's revenue, followed by Europe and Africa at 32% combined, and Asia at 21%. IBM focuses on enabling entities of all sizes with platforms to match their demand for computing power.

Personally having been in the IT industry for over 10 years, I have yet to see a data center where you can’t find an IBM product.

IBMs 3 major business units, accounting for over 88% of its revenue, span the following:

Global Technology Services - infrastructure and platform services including its hybrid cloud solutions and enterprise application management.

Cloud & Cognitive Software - software solutions for data, blockchain and artificial intelligence. One of their most well-known solutions is IBM Watson, an artificial intelligence system, trained to answer questions using natural language processing methods.

Global Business Services - strategy consulting and business process optimization services. The major goal with these products is to enable customers to complete their digital transformation and level their path into a cloud/hybrid-cloud environment. The remaining 12% in revenue is generated by their hardware solutions and earnings generated through financing options for IBM's customer base.

Dividend Growth and Sustainability

IBM’s dividend yield as of 7/19/2020 is 5.21%. Compared to its peers in the technology sector, this is considerably high. The following will cover some history on and judge the sustainability of IBM’s dividend by examining the payout ratio as well as its growth to determine whether big blue makes a compelling case for dividend growth investors.

Dividend History & Growth

IBM has paid out a quarterly dividend consistently since 1916 and ultimately became a dividend aristocrat when their board declared their 25th consecutive annual dividend increase on April 28, 2020.

Though this is something to be celebrated and shareholders have seen an overall 150.77% increase in dividend per common share between 2010 and 2020, dividend growth itself has slowed down. Their latest dividend announcement noted a mere $0.01 per share increase compared to the 2019 growth of $0.05 alongside $0.07 in 2018, and $0.10 in 2017. Read on for details regarding IBM’s financials which might explain what has been contributing to this trend.

Payout Ratio

Between 2010 and 2019 IBM's payout ratio has been growing from 21.70% to a peak of 98.08% in 2018. Their 5-year-average payout ratio is 59.97%, suggesting to me that the company's dividend remains safe even with the current phase of transition and downward growth trends observed.

However, we likely won’t see significant growth until sales and business is growing again.

Financial Analysis

The financial health of IBM in its current state could be considered a major red flag for potential investors. Earnings and revenue have been on a steady decline since 2013 which is also the year the company's debt has been growing since. This debt peaked in mid-2019 at close to $73b, with a debt to equity ratio of 410.5%.

Though the pressure is on to reduce this debt while aiming to bring earnings back up, debt and interest coverage are covered by strong operating cash flow. Furthermore, interest payments are covered by EBIT at an 8.7x coverage-rate.

However, though it has yet to be confirmed if 2020 will follow suit, we could see things pick back up as earnings did see an uptick in 2019.

Investment Case

In the following section, we will dive into the company's Moat as well as Bull and Bear cases to outline which headwind the company might face while providing insight into their strategy and growth opportunities.

Moat

So what puts IBM at a competitive advantage over its peers? First off: Their main revenue is generated by businesses in change-resistant sectors. IBM has been part of the backbone of financial, healthcare, and telecommunication institutes for decades now. With privacy being one of the more prominent concerns over a potential adoption of cloud technology, IBM will continue to be the main provider of hardware and services for those sectors for years to come.

Adding to that IBM is the only vendor that has multiple systems on the list of Top 10 supercomputers. While this fact is already stunning enough, they supply two of the top three supercomputers in the world.

The Bull Case

IBM has managed many transitions throughout their existence. Blockchain technology, Artificial Intelligence as well as hybrid solutions between on-premise and cloud hardware will develop into the future for IBM.

Moreover, their change-reluctant customer-base will likely keep IBM as their backbone as transitions to cloud-based technology continues. Trust and relationships built over decades will lead customers to continue to choose IBM as a hardware supplier and service provider in the future as their mainframe technology remains a big and essential part of their business.

IBMs new CEO Arvind Krishna has a long history in their research division. An innovation-driven strategy, with a focus on artificial intelligence and hybrid cloud as key technologies, could help IBM to develop and scale new products to its huge customer base.

The Bear Case

Privacy-focused cloud solutions will make their way into customers of the finance, healthcare, and public sector. IBM’s current portfolio and revenue streams won’t be enough to compete with cloud giants like Amazon (Nasdaq: AMZN) and Microsoft (Nasdaq: MSFT).

While trying to shed less profitable business units, IBM has struggled to generate meaningful growth in sales. Their massive payroll for over 350,000 full-time employees and the aforementioned debt will become an issue if the company is unable to grow to cover these costs.

Conclusion

Declining fundamentals have prevented me from averaging down on my current position. While a forward P/E Ratio > 10 seems very attractive, especially for a tech giant, I have yet to see consistent good news and quarterly reports.

Financial engineering over the last few years has been their vehicle of choice to boost EPS and the Red Hat acquisition has yet to bear fruit. Their core business is on a decline and will be challenged more and more as cloud providers fight for market share and individual data centers are not the option of choice for small and medium businesses anymore.

I recommend potential investors browse through the documents found on IBM’s investor relations page.

Thank you for taking a look at my stock analysis of IBM. Let me know what you think. I invite you to share any feedback you have to offer to help me improve future research!

Disclaimer

I hold a long position in International Business Machines (NYSE: IBM). This article expresses personal opinions and observations of someone who is not licensed to provide financial advice.

I am not receiving compensation for writing this analysis and have no business relationship with any company whose stock is mentioned in this article other than the long positions I own. Furthermore, I cannot guarantee the accuracy of the financial metrics gathered from 3rd party services like Morningstar and Yahoo Finance.

Post Comments(3)

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derek@engineermyfreedom.com July 28, 2020, 2:02 a.m.

Hey man, great write up as usual. Il be keeping an eye on red hat to see how they will be performing

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Just-Dividends July 28, 2020, 9:38 a.m.

Hi Derek, the Red Hat acquisition has a lot of upside for IBM. They venture into a new market but it remains to be seen whether this business offers sustainable growth. Red Hat's focus is on open source technology and charing for its support which is a very resource-intensive business when done right.

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Chris@TTL July 29, 2020, 12:23 a.m.

I appreciate that it's way outside the fundamentals, but what do you think about Buffet's exit a few years ago from IBM? I feel like it might not be a great sign from a guy that tends to focus on value, which usually indicates there's more room for dividends. Then again, he did largely make the switch to Apple right after...

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