IBM's (IBM) incredible surge on Wednesday morning is still drawing skepticism from analysts on Wall Street who question the company's ability keep up with ambitious spending programs and colossal competition.
Shares of the storied tech titan soared nearly 10% on the open as a pivot to more profitable long-term trends buoyed buying action on the low PE tech stock. Shares were up 7.5% to $131.76 as of 12:30 p.m. ET.
However, as the company sets its sights firmly on cloud, AI, blockchain, and big data; the evolving nature of the sector, existing players in these segments, lack of stable revenue from the company, and the capital expenditures needed to accelerate growth are keeping analysts steadfast in their belief that a discount to its peer group is still prudent.
"We maintain our Neutral rating on IBM and maintain our 12-month price target of $140, viewing a stabilization of the core business and subsequent return to growth and margin expansion as necessary for multiple expansion," Cantor Fitzgerald analyst Joseph Foresi explained. "Our lower multiples reflect our projected flat constant currency 2019 growth rate, near the bottom of the peer group."
Keeping Up With Cash Flow
A persistent concern for "Big Blue" is its cash flow capability.
Cash flow has come down significantly in recent years as the company's seeks to right its ship and navigate to gains with new technology focuses.
Cash flow for the year 2018 came in a bit under estimates, at $11.9 billion compared to an initial forecast of $12 billion.
IBM CFO Jim Kavanaugh said he sees free cash flow for 2019 bumping up to the $12 billion figure, combating the company's $67.3 billion in total debt that was ballooned by the company's $34 billion acquisition of Red Hat (RHT) .
"We returned over $10 billion to shareholders in the year, including dividends of $5.7 billion," Kavanaugh said. "We've now increased our dividend per share for 23 consecutive years, and we remain committed to continued dividend increases. We also bought back just under 33 million shares, reducing our average share count by over 2%. At the end of the year, we had $3.3 billion remaining in our buyback authorization."
While a steadily increasing dividend is a positive for most stocks, many have highlighted the company's need to reinvest in order to reinvent itself. This is not helped by consistent cash return to shareholders, enticing as that may be in the short term.
Additionally, while Kavanaugh touted the remaining share repurchases, the buyback plan will be suspended into 2020 and 2021 in order to deal with the Red Hat integration, tempering that impact for the long term.
"Our rating remains Market Perform in part reflecting the upcoming two-year pause in share repurchase as free cash flow is directed to the Red Hat cash acquisition," Wells Fargo analyst Ed Caso said. "Our price target [is cut to] $140 from $155 reflecting a lower market multiple and the lack of 2020-21 share repurchase expected, offset by signs of further progress in their digital transition."
The sizable debt load could cull the company's ability to continue investing heavily, while its pullback on share repurchases will cut off a degree of share growth, leading to the question marks still present in the minds of analysts, especially as divestments of certain business will be necessary to deliver on cash flow promises.
IBM has announced two divestitures within just the last two months, in Seterus mortgage servicing and HCL technology, indicating its need to supplement cash reserves amid dividends, repurchases, and acquisitions.
IBM management charted the revenue from these divestitures at about $1.5 billion in the call with analysts and factored the impact into small headwinds to be realized in the software segment in the nearer term.
Keeping Up With Competition
As the company pivots and invests in these growth oriented segments, the competition also puts in a significant potential speed bump for the company's secular growth story.
"IBM competes in several concentrated and rapidly evolving markets," BMO Capital Markets analyst Arvind Ramnani said. "It faces competition from cognitive solution vendors, global business and technology service vendors, and systems vendors."
Among these major competitors specifically in hybrid cloud which has become the main focus of the company's increased investment, namely through Red Hat, comes into a direct clash with Microsoft's (MSFT) Azure product and Amazon (AMZN) web services.
"IBM has been allocating resources away from certain segments of the IT industry, directing R&D investments into segments that gain more value from the Company's innovation initiatives," Ramnani explained.
He said that any execution risks on these numerous question marks still ahead, will temper the company's growth trajectory that is being celebrated on Wednesday.
Ramnani set a $128 price target on the stock, below the Wednesday morning share price.
The execution of these projects, specifically in cloud, still runs into the significant issue of competition from AWS, Azure, Alphabet's (GOOGL) Google Cloud, as well as Alibaba (BABA) and Tencent's (TCEHY) own offerings.
According to Synergy Research Group, IBM remains a distant third in the cloud race behind Amazon and Microsoft, while Google's offering is neck and neck for the bronze.
Microsoft and Amazon together control about 50% of global cloud market share at year end 2018 with each increasing market share into the end of the year. Meanwhile, IBM's market share dropped slightly and is threatened by the ascendant Alibaba and Oracle globally for its ranking.
Defensive Character Defends Buying Thesis?
While some have questioned the company's focus on dividends even as it needs to innovate and spend, others have highlighted the characteristic as an important downside protection for a rare, defensive tech stock with a low price to earnings ratio.
Stifel analyst David Grossman gave IBM a "Buy" rating and an $145 price target due to what he termed an undue discounting of the company's growth profile.
"At a 5% dividend yield, we believe the market is discounting IBM [on the expectation it] will remain in secular decline independent of its various growth initiatives and that the current level of free cash flow generation, which covers capital returns and acquisitions, is unsustainable," he explained.
While Grossman acknowledged this risk, he concluded that the company's upside outweighs the downside that is appearing protected against.
"While risk is elevated given slower than expected revenue stabilization, we believe the risk reward remains attractive given very negative market sentiment and several potential catalysts over the next 12 months, which could drive both estimates and the multiple higher," he concluded. "Given its defensive characteristics, prospects for continued growth in Cognitive/Services and margins in 2019 and the RHT deal closing in the second half of 2019, we believe the narrative should begin to turn more positive and allow the stock to build a base from current levels."
The question that will remain for shareholders and speculators on the stock today will be whether the company has the necessary capital to capitalize on its cloud and cutting edge tech aspirations and make a dent in the deep field of competition obscuring its aims.
For one, IBM is a stock that Jim Cramer likes after it took such a significant multiple cut in 2018.
"I was very cheered by IBM," he said. "I think it was a very good quarter...it shouldn't have been where it was."
To hear more on where the stock is headed after surging on Wednesday, check out chart master Bruce Kamich's commentary on the charts here.