Leveraging Red Hat And OpenShift Will Elevate Future Performance

Key Takeaways

• IBM's focus on hybrid cloud and AI, along with key acquisitions, is set to drive revenue growth and enhance its market position.
  
• Strong recurring revenue and productivity initiatives are likely to improve net margins and provide financial stability.
  
• Challenges in consulting and infrastructure sectors, alongside uncertainties in macroeconomic conditions, may impact IBM's revenue growth and profitability despite potential growth from acquisitions.

Catalysts

Provides integrated solutions and services worldwide.

• IBM's shift towards higher growth and higher margin areas such as hybrid cloud and AI, as evidenced by the accelerated software revenue growth and increased contribution from platforms like Red Hat and OpenShift, is expected to drive significant revenue growth.
  
• The company's continued strength in recurring revenue, with approximately 80% of its software revenue being recurring, is likely to provide stability and predictability in earnings, positively impacting net margins.
  
• The anticipated mainframe cycle, specifically with the introduction of next-generation processors like Telum II, is expected to contribute significantly to infrastructure revenue growth, aiding overall revenue and earnings.
  
• Increased productivity initiatives aimed at achieving $3.5 billion in annual run rate savings by the end of 2024 are likely to enhance operating margins and boost net margins and overall profitability.
  
• IBM's strategic acquisitions, such as HashiCorp, and potential future acquisitions aligned with hybrid cloud, automation, and AI, are expected to bring synergies and drive revenue growth and market share, positively impacting the financial outlook for 2025 and beyond.

International Business Machines Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming International Business Machines's revenue will grow by 4.4% annually over the next 3 years.
• Analysts assume that profit margins will increase from 10.2% today to 13.0% in 3 years time.
• Analysts expect earnings to reach $9.3 billion (and earnings per share of $9.62) by about December 2027, up from $6.4 billion today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as $7.2 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 28.5x on those 2027 earnings, down from 33.2x today. This future PE is lower than the current PE for the US IT industry at 43.8x.
• Analysts expect the number of shares outstanding to grow by 1.39% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.11%, as per the Simply Wall St company report.

International Business Machines Future Earnings Per Share Growth

Risks

• The uncertain macroeconomic environment, including geopolitical issues and fluctuating interest rates, is impacting discretionary spending, leading to lower-than-expected results in IBM's Consulting business, potentially affecting revenue growth.
  
• Consulting signings have declined for two consecutive quarters, indicating potential difficulties in converting new business opportunities into sustainable revenue, which could impact overall earnings.
  
• IBM's infrastructure revenue experienced a 7% decline, reflecting product cycle dynamics and declining IBM Z revenue, which could pose risks to future revenue and profitability.
  
• Challenges in the Consulting sector, including flat revenue and clients reprioritizing spending away from on-premise services, may continue, potentially impacting net margins.
  
• The integration and expected contributions from acquisitions, such as HashiCorp, could present execution risks and may initially dilute margins and earnings before realizing the anticipated growth benefits.

Valuation

• The analysts have a consensus price target of $217.12 for International Business Machines based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $260.0, and the most bearish reporting a price target of just $139.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $71.1 billion, earnings will come to $9.3 billion, and it would be trading on a PE ratio of 28.5x, assuming you use a discount rate of 8.1%.
• Given the current share price of $228.97, the analyst's price target of $217.12 is 5.5% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.