Where Was The Bright Spot In IBM's Earnings?

Although International Business Machines Corp. IBM reported strong Q3 headline results, its core margins weakened, with rising investments, Goldman Sachs’ James Schneider said in a report. He maintained a Neutral rating on the company, while reducing the 12-month price target from $147 to $145.

IBM reported its Q3 revenue at $19.2 billion, marginally higher than the Goldman Sachs estimate of $19.1 billion and the Street expectation of $19.0 billion. Non-GAAP EPS came in at $3.29, beating the Goldman Sachs estimate of $3.31 and the Street’s $3.23 projection.

IP income and a tax benefit offset core margin contraction, with gross margin declining 210bps y/y as IBM continues to ramp investments, analyst Schneider noted.

The EPS estimates for 2017 and 2018 have been reduced from $14.70 to $14.50 and from $16.00 to $15.80, respectively, to reflect lower gross margins.

Takeaways

“Although IBM’s headline results were solid, the tepid underlying trends in most of its segments remain unchanged – with Software still declining organically driven by transactional weakness, and GBS under pressure given competitive and execution issues,” Schneider wrote.

The analyst mentioned the “bright spot” in IBM’s Q3 results as the performance of Tech Services & Cloud, saying that checks indicate continued favorable trends. He expressed concern, however, regarding the significant gross margin contraction across various business, as IBM would likely continue to reinvesting in a bid to stabilize revenue, since the company’s most profitable business remains under pressure.

Schneider commented that a revenue inflection was needed to drive IBM’s multiple expansion from current levels.
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