IBM's So-So Quarter Was Actually Better Than It Seems

The critics have a point. International Business Machines (NYSE: IBM) may have topped its first-quarter sales and earnings forecasts, but its sales fell again on a currency-adjusted basis, as did its operating income. Operating earnings per share fell 4% to $1.77 from $1.84 in the year-ago period.

And bear in mind that the pandemic was already rattling the world during the first quarter of 2020, crimping many corporations' results before last March came to a close. The bar for IBM was set pretty low to begin with.

However, there's a reason IBM shares climbed by 4% in response to Monday's post-close release of its Q1 numbers. Big Blue is showing serious progress on one metric that arguably matters more than the top or bottom lines do right now: cash flow. The company is producing more and more of it, and continued growth is in the cards.

Woman's hand placing five gold stars.

Image source: Getty Images.

Turning a big boat around takes time

For the first quarter, IBM's operating cash flow grew by nearly 10% to a little over $4.9 billion. Adjusted free cash flow, which subtracts costs linked to restructuring and spinoffs, expanded from $1.36 billion to $2.15 billion. That's 58% growth.

Were Q1 the first time we saw such progress from the company, it might be dismissible. This isn't a one-off, however. After years of deterioration, IBM's cash flow has been improving since 2018 -- the point when its so-called "strategic imperatives" businesses, such as cloud computing, cybersecurity, and artificial intelligence, started regularly accounting for more than half of its revenues. Last quarter's numbers merely extend this trend.

The graph below puts things in perspective. While the turnaround has been inconsistent and volatile, the overall direction is still clear ... and becoming increasingly so. Last quarter's cash flow was IBM's strongest Q1 cash flow in years, extending a turnaround that solidified last year.

IBM's earnings growth has been tepid, but cash flow from operations has been growing reliably for a couple of years now.

Data source: Thomson Reuters. Chart by author.

More progress ahead for IBM

Look for more of the same progress going forward. IBM is guiding for full-year adjusted free cash flow of between $11 billion to $12 billion. That's in line with the $11.6 billion in adjusted free cash flow generated across the past four reported quarters, and up slightly from 2020's figure of $10.8 billion.

It's also not a stretch to wonder if management is under-promising just so it can over-deliver. Technology market research outfit Gartner estimates that spending on public cloud solutions will grow by more than 18% this year, while Mordor Intelligence forecasts the hybrid cloud computing market will grow at an annualized pace of more than 18% through 2026.

Both outlooks bode well for IBM. Cloud computing was a decided bright spot for the company last quarter, as overall cloud revenue improved to the tune of 19% on a currency-adjusted basis. And CEO Arvind Krishna has made a point of prioritizing hybrid cloud solutions since taking the helm a little over a year ago.

Take the hint

The company isn't just shifting away from its legacy business lines and toward more modern, marketable ones either. Operations are being tightened up too, as is the balance sheet. IBM reduced its debt load by $5.1 billion during Q1, lowering its future interest expenses. This progress is a credit to Krishna, although it would be amiss to not acknowledge the role now-former CEO Ginni Rometty played in IBM's ongoing evolution.

For investors though, the big takeaway is that it's finally starting to come together. With real free cash flow growth now the norm, IBM can start playing a little more offense and a little less defense.

There's more work to be done, to be sure. At best, sales have only stabilized, and operating income remains hit or miss. Even analysts agree, however, that profit growth is in cards for the near future, in step with sales growth (once the world more fully shakes off the impact of the pandemic).

Analyst expect IBM to start producing revenue and profit growth.

Data source: Thomson Reuters. Chart by author.

This all makes IBM an interesting investment prospect, even if it's not the sort of holding you'd want to pick as a core pillar of your portfolio.

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James Brumley has no position in any of the stocks mentioned. The Motley Fool recommends Gartner. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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