2020 could be transformational for this tech behemoth

Having underperformed the market over five years, things could change for this biggie next year.

27th November 2019 10:50

Having underperformed the market over five years, things could change for this biggie next year.

Rodney Hobson is an experienced financial writer and commentator who has held senior editorial positions on publications and websites in the UK and Asia, including Business News Editor on The Times and Editor of Shares magazine. He speaks at investment shows, including the London Investor Show, and on cruise ships. His investment books include Shares Made Simple, the best-selling beginner's guide to the stock market. He is qualified as a representative under the Financial Services Act.

As the technological revolution took off at the end of the 20th century, there were genuine fears that International Business Machines (NYSE:IBM)was being left behind with the dinosaurs. But the company has reinvented itself, offering a variety of IT services, software and hardware with operations in 175 countries, and looks a solid, reliable performer in a sector where the finger of fortune can be very fickle.

Once IBM was a target for those who thought that it was too big and powerful and ought to be broken up; now that kind of accusation is directed against the likes of Microsoft (NASDAQ:MSFT), Amazon (NASDAQ:AMZN), Alphabet (NASDAQ:GOOGL) and Facebook (NASDAQ:FB). The regulatory heat is off IBM.

Source: interactive investor Past performance is not a guide to future performance

Results this year have admittedly not been great. Earnings per share in the first nine months were down 12% from $7.37 in the same period of 2018 to $6.45 and net income fell 15%, although the falls were exaggerated by foreign exchange movements.

Revenue was hurt by weak performances in three divisions: services, global technology services, and global financing. IBM also had to digest the $34 billion acquisition in July of cloud technology specialist Red Hat.

IBM does expect a stronger fourth quarter, although investors have to take that on trust. It forecasts earnings per share to be at least $10.58, up from $9.51 last time. While that will still leave the total for the year below last time, it does mean that the year ends on a promising note and next year the company will be up against less demanding comparatives. Also encouraging is that free cash flow is strong and should hit $12 billion.

There are also great hopes that adding Red Hat to IBM’s industry expertise, and its access to markets across the globe, will lead to the creation of the next generation of hybrid multicloud platforms, which allow businesses to store and manage data and computer applications on their own premises and also on private and public computer clouds.

IBM’s cloud income has grown from 4% of group revenue in 2013 to 25% in the third quarter of this year, and it reckons that Red Hat will add two percentage points of compound annual growth in revenue for at least five years. Red Hat’s revenue in its latest financial year was $3.4 billion, up 15% year on year. That rate of growth has continued into its 2019-20 financial year. IBM’s cloud revenue is running at about $19 billion a year. Analysts believe that the outlook for cloud data centres generally is improving.

The hope is that a new arrival on IBM’s board, Thomas Buberl, who has overseen digital transformation at two European-based international insurance giants, AXA and Zurich Insurance, will bring extra insight in this area. He joins in April.

In a separate development, IBM’s Japanese arm is to work with Panasonic Corp to improve semiconductor manufacturing. The two companies will jointly develop a data analysis system that will be incorporated into Panasonic devices to significantly reduce the number of engineering processes required.

IBM shares have had a pretty erratic ride over the past few years, touching a high of $181 and hitting a low of $111 just before Christmas last year. A recovery petered out at $151 this summer and the shares are now fluctuating around $135. The yield of 4.8% is attractive and the price/earnings ratio of 15.6 is not particularly demanding, especially compared with other large companies quoted in New York.

Hobson’s choice: Next year could be transforming for IBM. Even if it turns out to be quite ordinary, the downside for the shares looks limited to $130. Buy up to $139, which has proved both a ceiling and a floor in the past five months.

Rodney Hobson is a freelance contributor and not a direct employee of interactive investor.

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