After Q3 Revenue Slowdown, Can IBM Finish The Year On A Strong Note?

IBM (NYSE:IBM) announced its third quarter 2018 earnings on October 16, reporting a 2% decline in revenues to $18.8 billion. Global Business Services and Systems revenues were flat over the comparable prior year period at $4.1 billion and $1.7 billion, respectively. Comparatively, other revenue streams such as Technology Services ($8.3 billion), Cognitive Solutions ($4.1 billion) and Global Financing ($388 million) faced single-digit declines in Q3. The tech giant reported modest mid-single digit growth across segments through the first half of the year, which was offset by slightly lower gross margins. However, the trend reversed in the third quarter with lower revenues but a flat gross margin over the prior year quarter. The improving gross margin trend was driven by a better product mix and improvement in services margins. Consequently, the company’s non-GAAP diluted EPS stood at $3.42, or 4% higher on a y-o-y basis. We expect the trend from Q3 to continue through the end of the year as well. We have summarized our full year expectations, based on the company’s guidance and our own estimates, on our interactive IBM earnings dashboard. If you think differently, you can change expected segment revenue, gross margin and net income margin for IBM to gauge how changes will impact its expected EPS.

Key Growth Trends

After a 2-3% revenue decline in the last couple of years, Global Business Services revenues have rebounded to low single digit growth (+3%) through the current year thus far. This has been the only segment that reported  consistent growth through all three quarters of the year. IBM reported robust growth from Systems in the first half due to strong demand for all three offerings including IBM Z, Power and Storage. However, revenue growth slowed down in the third quarter. While Z system revenues continued to impress, IBM reported weakness in software revenues.

Going forward, we expect the company’s Technology Services and Business Services revenues to grow in the low single digits, keeping up the trend from recent quarters. Similarly, Systems revenues are also likely to be up in high single digits, while Cognitive Solutions revenue is forecast to remain flat over 2017 levels. As a result, IBM’s net revenues for the year are forecast to see a 2% increase to $81 billion, per Trefis estimates. We forecast the company’s gross margin to compress by 70-80 basis points for the full year, while net income and EPS are likely to be roughly flat over 2017 levels. We expect IBM’s diluted EPS for the full year to be around $13.95, which is about in line with consensus estimates.

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