International Business Machines Corp. shares slumped Thursday after analysts picked apart Big Blue’s free cash flow results and outlook, and found a “mixed blessing” in the company’s drive to shift focus away from earnings per share.
shares fell as much as 5.5% to an intraday low of $132.98, while the Dow Jones Industrial Index
— which counts IBM as a component — was up 0.2%, the S&P 500 index
rose 0.5%, and the tech-heavy Nasdaq Composite Index
Late Wednesday IBM reported its largest sales increase in a decade, coincidentally an increase of 5.5% to $60.53 billion, but Wall Street on Thursday was much more concerned with free cash flow, or FCF, that came in at $9.3 billion, well below Wall Street expectations, and forecast 2023 FCF of $10.5 billion.
Analysts surveyed by FactSet had forecast FCF of $11.03 billion prior to earnings. A year ago, IBM Chief Executive Arvind Krishna had forecast $10 billion to $10.5 billion of FCF in 2022, and had refused to issue an EPS forecast.
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MoffettNathanson analyst Lisa Ellis said IBM’s report showed the “mixed blessing” of FCF at work. Ellis said that when Krishna became chief executive three years ago, he eliminated any focus on earnings per share, opting to focus more on revenue growth and FCF.
“The mixed blessing of the FCF-centric objective is that there’s nowhere to hide —it’s transparent, and it is what it is, for better or for worse,” Ellis said.
One example Ellis cited, and one of the reasons she upgraded IBM to market-perform last week was the company’s divestiture of its managed infrastructure-service business that became Kyndryl Holdings Inc.
Ellis said that while Kyndryl before the spinoff was contributing nearly $20 billion, or 25%, to revenue, the segment was accounting for less than $1 billion, or 10%, to FCF, and that contribution was on the decline.
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Morgan Stanley analyst Eric Woodring, who has an equal-weight rating and a $143 price target, said FCF missed his estimate by 30%, “implying a steep ramp to meet IBM’s CY22-24 target.”
That said, Woodring said that 2023 “remains a show-me story.” Even as IBM makes improvements to its partner ecosystem, “we still view valuation as rich in the context of slowing growth.”
IBM shares, even with Thursday’s drop, are up 0.5% over the past 12 months, compared with a 7% drop on the S&P 500.
Stifel analyst David Grossman, who has a buy rating and a $150 price target, said IBM’s stable revenue trends were “overshadowed” by a “sluggish FCF guide.”
“Despite in-line revenue and continued margin expansion, FCF remains in the $10bn range, after normalizing for working capital tailwinds, which is a gating item,” and likely explains pressure on the stock, Grossman said.
“Defensive and/or dividend (4.7%) holders may be satisfied; however, the 4Q result and outlook are unlikely to attract incremental interest, which increases risk that IBM becomes a source of funds if treasury rates remain elevated or sentiment improves,” Grossman said.
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B of A Securities analyst Wamsi Mohan, who has a buy rating and a $152 price target, said “investors may be concerned about the trajectory of the business in 2023 given management commentary suggests that profitability will be skewed more to 2H (67%) than a typical year (61%).”
“Although rev in 1Q will be in the target model on a constant currency basis, 2Q will face tough comps from a strong mainframe launch last year,” Mohan said.
Out of the 18 analysts surveyed by FactSet that cover IBM, five have buy-grade ratings, 12 have hold ratings, and one has a sell ratings, along with a average price target of $144.82, compared with $140.29 at the end of 2022.