* Reports Q1 2019 results on Tuesday, April 16, after the market close
* Revenue Expectation: $18.52 billion
* EPS Expectation: $2.22
There's a lot at stake for International Business Machines (NYSE:IBM) when the company reports its first-quarter earnings tomorrow. Primarily, it needs to prove that investor optimism about its revival is justified and that it’s well on track to consistently beat expectations.
If Big Blue is successful in showing that its turnaround is gaining momentum, this year's powerful rally—which put the company's shares among the best performing blue-chip stocks on the Dow Jones Industrial Average—is likely to continue.
Shares of this legacy tech giant, which dominated computing's early decades with inventions such as the mainframe and later the floppy disk, closed Friday's session at $144.35 — up more than 25% this year. They've gained 34% since hitting the December low, outperforming both the S&P 500 (+20.3%) and the tech-heavy NASDAQ 100 (+26.2%).
IBM bulls have focused on the company’s strong showing during the fourth-quarter of 2018 and its upbeat forecast for the current year. After beating analysts' revenue estimates in the Q4, IBM said in January that it expects adjusted earnings per share of at least $13.90 in 2019, ahead of analysts’ predictions of $13.89. This was the second quarter in a row in which IBM showed growth, after six years of revenue declines.
Game-Changing Acquisition
With the recent upsurge in its stock, investors may be concerned that this rally has run its course and the stock is therefore becoming risky. In the short-run, that fear could be true, but we are becoming more confident that the company is on the right track to achieve its long-term turnaround plan.
The linchpin of IBM's growth strategy was to arrest a slowdown in sales by capturing a larger share of new growth areas of the digital economy. That goal remained a distant dream until last year as the company’s efforts to grow organically failed to produce results and satisfy investors.
But that won’t be the case going forward. In our view, the company’s $33-billion purchase of Red Hat (NYSE:RHT) last year will prove a game-changer. This acquisition will add a relatively high-margin software business to IBM’s stable of offerings, especially in the hybrid cloud services to corporate customers it brings.
About 85% of all enterprises are expected to adopt a hybrid cloud approach in which most will use a mix of public cloud services like Amazon Web Services (NASDAQ:AMZN) alongside their own private cloud networks, according to a forecast from Jefferies & Co.
For long-term investors whose aim is a steady income stream, owning IBM stock makes a lot of sense. The company plans to return about 70%-80% of free cash flow to shareholders each year, with annual dividend increases and continued share buybacks.
Bottom Line
IBM stock continues to remain an attractive turnaround bet, suitable for long-term investors with a 5-10 year time horizon. Despite the recent rally, its stock still yields 4.4%, double the S&P 500′s 2% average. The company has increased its dividend five times in the past five years. We believe the upside potential remains strong, if the company again delivers a positive surprise in its Q1 results.
For those with the patience to hold on to this investment, IBM shares could prove to have good value, especially given the company’s Red Hat acquisition alongside its legacy businesses continuing to provide recurring cash flows.