After a misstep last quarter, the turnaround at IBM got back on track with 4Q21 results exceeding expectations.  The big upside was in revenue which beat street estimates by several percent.  Growth showed up in the right places with software, hybrid cloud, and consulting all strong.

Stock Reaction:  IBM shares were up almost 6% on another tough day for the broad market.  This is a good sign that Northlake’s investment thesis at IBM is beginning to gain traction.  Besides the good results, the shares continue to benefit from rotation toward value stocks.  IBM has a low P-E and pays a high dividend, two characteristics of value stocks.

Earnings Analysis:  A return to growth at Software and an acceleration to over 20% growth for Red Hat highlighted IBM’s strong quarter.  The revenue beat flowed through to EPS although management is no longer guiding to EPS, instead focusing solely on revenue growth and free cash flow.  The lack of EPS guidance created a little controversy on the earnings call.  There was also confusion and some skeptical questioning about the company’s guidance for $10-10.5 billion in free cash flow for 2022.  We thought management explained the guidance well.  The company provided dramatically improved new disclosure on revenue growth drivers in the new simpler, more direct segment reporting.  The added disclosure boosted confidence in the 2022 guidance for mid-single-digit revenue growth, albeit 60% weighted to 2H22.

Target Price:  4Q21 was another step in the right direction for IBM shares.  The company still has plenty to prove before investors accept the company’s guidance for mid-single-digit long-term revenue growth and pickup in free cash flow to a $12 billion average over the next three years.  The proof will come from steady execution over the next few quarters.  Now that the Kyndryl spinoff is complete, the path to steady revenue growth can be seen more clearly.  Investors are beginning to reward IBM shares.  The stock is up 3% this year against the big stock market correction and up almost 20% since the low around Thanksgiving.  The return has been further juiced by another dividend payment and the Kyndryl spinoff which Northlake sold for the equivalent of more than $5 per current IBM share.  We still see upside to $160 in 2022 driven by modest multiple expansion as the company executes towards its near and long-term guidance.  IBM shares also yield nearly 5% on the current dividend.

IBM is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.