IBM Stock: Is This Earnings Dip an Opportunity … or an Omen?

The turnaround effort from International Business Machines is interesting, even if nobody but the company has faith in it

The good news is, International Business Machines Corp. (NYSE:IBM) managed to top earnings estimate in the fourth quarter of 2014.

IBM stockThe bad news is, that’s the only good news one could glean from the struggling technology company’s Q4 results.

IBM Earnings: The Numbers

All told, “Big Blue” earned $5.81 per share of IBM stock last quarter, topping average estimates of $5.41, though falling short of year-ago figures by a not-insignificant 6%. Revenue fell almost 12% in Q4, to $24.11 billion, although sales were only down 2% when factoring on currency volatility and adjusting for business units that the company divested within the past year.

Those figures capped off a similarly miserable year. For all of 2014, revenue was down 6% to $92.8 billion, and profits fell 9% to $16.7 billion.

IBM earnings were accompanied by a 2015 outlook that also was less than thrilling. Now the technology services giant believes it will generate income of somewhere between $15.75 and $16.50 per share of IBM stock, versus an average analyst estimate of $16.53 before the latest guidance was released.

In the context of IBM’s ongoing deterioration (International Business Machines just logged its 11th straight quarter of declining year-over-year sales) and in the shadow of Wednesday’s pullback, investors have to ask themselves one question?

Is IBM stock a lost cause?

A Work in Progress

Just so there’s no confusion, the International Business Machines management team is well aware that what it’s doing hasn’t been working. It actually figured that out a more than a year ago, and has been working to effect change ever since.

A $155 billion corporate behemoth doesn’t turn quickly, though, especially when it’s navigating uncharted waters. And those waters are cloud computing and all its ancillary business lines, like cloud security.

Wading deeper into cloud waters has at least partially meant getting out of businesses that no longer fit. For example, in October, IBM shed its low-end server business to Lenovo Group Limited (ADR) (OTCMKTS:LNVGY). In fact, all the units the company shed in 2014 sacrificed $7 billion worth of annual revenue, and more divesture is on the way. IBM has already lined up the sale of its chip-manufacturing business to Global Foundries this year.

It’s worth it to IBM, however, all in the name of a tighter focus and eventually, widening margins. But it’s a transition that will take time.

In the meantime, International Business Machines is also making a proactive effort to win more cloud market share, where margins are higher than those generally achieved in the hardware game. Indeed, all of the new focal points grew quite nicely in 2014. Its cloud, security, analytics, and mobile business units collectively grew revenue to the tune of 16% last year.

Problem: Together, those divisions still only make up 27% of the company’s total revenue.

While IBM has somewhat grown those businesses organically, the organization acknowledges it’s better served — and faster served — by acquiring its way into the cloud market. The 2013 acquisition of SoftLayer and 2014’s purchase of Cloudant underscore the idea that the company intends to buy its way to the front of the cloud race.

But if it works, it works. And so far, it works.

Should You Buy IBM Stock?

While the headwind that International Business Machines has been hitting is undeniable, equally undeniable is the fact that IBM is making changes, and will eventually become a proverbial “final product.” Although 2015 is still likely to be a year of transition, veteran investors know that stocks tend to take a turn for the better well before a turnaround effort gets full traction.

With that in mind, is now the time to step into a long-term position in IBM stock, faithful the once-great company will find its way again?

In a word, no.

While there’s often good reason for a contrarian attraction to a stock that most everyone hates, IBM stock isn’t yet ripe to surprise the pessimistic masses. Instead, the lingering concerns regarding International Business Machines are all well-founded, and based on real factors.

Credit Suisse analyst Kulbinder Garcha best sums up the market’s response to the IBM earnings report by saying:

“Similar to last year, IBM guidance for EPS could prove optimistic for several reasons. First, an assumed stabilization in the software business could prove optimistic, in light of high levels of hardware attach and a long transition to a SaaS business model. Second, while management is counting on the effect of recent restructurings, we find this has become less and less effective. Third, FCF per share in FY15 will now be around $13.30 (on an IBM definition and $10.65 on a standard definition). With cash flows leading NI, this suggests a lack of earnings growth for IBM.

For Services we see a weak order book and shrinking industry-wide deal sizes causing revenue headwinds and margin pressures; (2) We believe the shift to the Cloud maybe ultimately be margin dilutive for IBM even if it drives revenue for the company; (3) Restructuring becoming less effective; (4) Our previous concerns over the significant rate of organic declines remain.”

In other words, International Business Machines is still struggling to find its footing, and IBM stock isn’t out of the woods yet.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

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