For International Business Machines Corp., earnings may need to be “nearly pristine” to preserve the stock in a tough environment for companies’ tech-budget decisions.
IBM IBM, -0.25%, which now receives about three-quarters of its revenue from tech services, reports first-quarter earnings Wednesday after the close of markets. In a recent note, Morgan Stanley analyst Erik Woodring said he is leaning “tactically cautious” into the report because of continued uncertainty about IT budgets in 2023.
“IBM needs to print a nearly pristine [first quarter],” Woodring wrote. “Otherwise, any small blemishes in the quarter are likely to result in post-earnings stock weakness (and lower conviction in achieving [calendar 2023] expectations),” Woodring said.
Woodring wrote that spending intentions from his first-quarter survey of chief information officers were “largely negative,” suggesting budgets for tech services continue to tighten. The analyst, who has an in-line rating on IBM and a $143 price target, added that he is watching for 2023 revenue growth, particularly in Red Hat, and any deal commentary.
Read from January: Morgan Stanley reverses IBM upgrade after 9 months as stock outperforms broader market
The most important metric, though, could be IBM’s free cash flow figures, and any change to the 2023 outlook. Even though IBM posted its biggest sales increase in nearly a decade while cutting thousands of jobs a quarter ago, analysts were laser-focused on free cash flow, or FCF.
FCF for 2022 came in well below expectations at $9.3 billion, and executives’ forecast for $10.5 billion for 2023 also fell below the Street consensus of $11.03 billion at the time. Analysts currently expect $10.45 billion in FCF for the year, with $1.6 billion of that in the first quarter.
Read: IBM’s ‘substantial’ dividend, debt take wind out of Big Blue’s sails as analyst downgrades stock
Stifel analyst David Grossman, who has a buy rating and a $150 price target, said IBM’s stock continues to find support with its 5.2% dividend — the fourth-highest on the Dow Jones Industrial Average — but the stock has been “a relative underperformer” over the past three months as investors have rotated into “more growth-oriented tech.”
That said, in-line results from IBM should be viewed “positively” given the traditionally weak first quarter and weak economic backdrop, Grossman said.
“Services may be a source of relative strength given backlog dynamics, mainframe remains ‘in-cycle’ and software will likely decelerate given the timing of [Red Hat] renewals and [enterprise licensing agreement] headwinds,” Grossman said.
Over the past few years, IBM has sought to transform itself from a mainframe company to a hybrid cloud services and software company, most recently spinning off its managed infrastructure-service business into Kyndryl Holdings Inc. KD, -1.08% in November.
Back in February, amid the surging popularity of Microsoft Corp. MSFT, +0.93% -backed Open AI and its ChatGPT generative AI, IBM Chief Executive Arvind Krishna said artificial intelligence was well on its way to replace humans for “clerical white-collar work.” Also, the Wall Street Journal reported recently that IBM was mulling a sale of its weather forecasting business, which includes Weather.com.
Over the past year, IBM has warned about currency headwinds because of strength in the dollar, with the U.S. Dollar Index DXY, -0.04% reaching a 52-week high in mid-September. Comparisons should be easier this report given the DXY index is only up 1.8%, compared with 12 months ago.
IBM shares are relatively unchanged from a year ago — up 1% over the past 12 months — and down 9.3% year to date. Meanwhile, the Dow Jones Industrial Average DJIA, +0.30%, which counts IBM among its 30 components, is up 2.5% year to date, while the S&P 500 index SPX, +0.33% is up 8.1%, and the tech-heavy Nasdaq Composite Index COMP, +0.28% has gained more than 16%.
Analysts estimate first-quarter earnings of $1.26 a share, down 10% from a year ago, on a 1.2% rise in revenue of $14.35 billion. IBM is expected to report a 1.2% rise in software revenue to $5.83 billion, while consulting revenue is expected to rise 3.7% to $5 billion and infrastructure revenue is expected to slip 1% to $3.19 billion.
Of the 18 analysts who cover IBM, six have buy-grade ratings, 10 have hold ratings, and two have sell ratings, along with an average target price of $145.79, according to FactSet data.
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