Goldman Calls IBM's Earnings Low Quality

“We remain Neutral on International Business Machines Corp. IBM as we think organic revenue inflection is needed to drive multiple expansion from current levels. We could be more constructive if we see evidence of sustained improvement in Software & Services revenue,” explained Goldman Sachs’ James Schneider, in a note, while maintaining a Neutral rating on the company, with a price target of $145.

Solid Results

IBM reported beat results for Q4, with revenue of $21.8 billion, marginally ahead of the estimate and the consensus, with non-GAAP EPS of $5.01, again ahead of expectations, driven by IP income and lower taxes offsetting a decline in gross margin.

The analyst believes the M&A added approximately 200bps to the revenue, while mentioning that software revenue grew 1 percent at constant currency, although it continued to decline organically.

Services signings declined 8 percent, while backlog declined 2 percent.

IBM guided to non-GAAP EPS for 2017 of “at least” $13.80, ahead of the consensus and estimate. The company expects an effective tax rate of about 15 percent.

Low Earnings Quality

“Although IBM’s headline results and guidance were solid, we expect the stock to see pressure post the report as we believe the underlying quality of IBM earnings – both in terms of revenue mix and core margin – remains low,” Schneider pointed out.

In addition, software growth continues to be under pressure due to transactional weakness, while the Global Business Services segment continues to see headwinds due to execution and pricing issues.

“The bright spot in IBM’s results remains Tech Services & Cloud, where our checks continue to suggest favorable trends. However, we believe the significant gross margin deterioration across the business suggests that IBM will need to continue reinvesting to stabilize revenue,” the analyst added.

In pre-market trading, shares of IBM were down 1.56 percent at $164.21.