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ΙΒΜ’s Turnaround Still Uncertain, Says Bernstein


The following is an excerpt from Tiernan Ray | February 6, 2017 | Barrons.com |

Bernstein’s Toni Sacconaghi today reiterates a Market Perform rating on the shares of International Business Machines, and a $150 price target, writing that despite rising investor hopes, “the company is still very much in the throes of a turnaround, with success uncertain.”

But the stock is up about 6% this year and 36% over the last twelve months. “So why has the stock been so strong?” asks Sacconaghi.

He opines it’s a bunch of things, mostly hope:

(1) Belief that IBM is nearing trough, and performance will improve/get less challenged going forward; (2) a market embrace of lower volatility and high dividend stocks; and (3) a relatively stable investor base (Buffett + index >40%). We also note that the stock is historically strong in the first quarter of each year, a phenomenon we have dubbed “the hope trade”.

But Sacconaghi’s feeling is, “We would need to see evidence that IBM is truly inflecting, or a much lower entry point, to recommend that investors build positions.”

Picking through the actual financials, Sacconaghi notes that IBM’s operating profit has been declining and looks still to be declining this year:

We believe that IBM’s operating income (which excludes interest income/expense, IP income and the impact of tax rate ) is the best view of the company’s fundamental profitability. We note that IBM’s operating income grew by at least $1.2B each year between 2007 and 2012, but has declined by over $2B in each of the last three years. In fact, operating income declined YoY by $3.4B in 2014, $2.2B in 2015 and $2.6B in 2016 – suggesting no inflection point this past year. On its earnings call, IBM pointed to operating profit improvement in FY 2017; however, we caution that the biggest source of operating profit improvement is lower restructuring expense, which IBM books in pre-tax income; we estimate that total restructuring expense might be $450M in FY 17 vs. $1.44B in FY 16. Excluding the change in restructuring expense, IBM’s FY 17 guidance implies that 2017 operating profit will decline about $300M, assuming an 11.5% tax rate (Exhibit 6). Looked at another way, after adjusting for a decrease in restructuring expense, a higher tax rate, and a lower share count, guidance implies that the underlying business fundamentals will deteriorate $0.32 per share.

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