International Business Machines (NYSE: IBM) reported its first quarter of revenue growth in over five years during the fourth quarter of 2017. When the company posts its results for the first quarter of 2018 after the market closes on Tuesday, investors will be looking for that momentum to continue.
Growth will be driven by IBM's strategic imperatives, which are closing in on accounting for half of the company's total revenue. This category includes fast-growing businesses like cloud computing, as well as major initiatives like artificial intelligence and blockchain. Currency will also lend a helping hand, with the weakening of the U.S. dollar set to provide a boost to IBM's internationally skewed top line.
The full-size z14 mainframe and the single-frame version. Image source: IBM.
What analysts are expecting
IBM blew past the average analyst estimate for revenue in the fourth quarter by nearly a half-billion dollars. That led to 3.5% year-over-year growth, its best performance in a very long time.
Analysts expect similar growth in the first quarter, with the average estimate calling for revenue of $18.82 billion, up 3.7% from the prior-year period. Some of this growth will be the result of currency effects, which added about 2.5 percentage points of growth during the fourth quarter. One important number to focus on is IBM's revenue growth rate at constant currency. This number will give investors a better idea of how fast the underlying business is growing.
Analysts expect non-GAAP earnings, what IBM calls operating earnings, to come in at $2.41 per share on average. That's up from $2.35 in the prior-year period. IBM expects its operating earnings for the full year to be roughly flat, partly due to a higher tax rate. IBM's non-GAAP tax rate excluding discrete items was 12% last year; it's expected to rise to 16% in 2018.
A mainframe boost and cloud growth
IBM started shipping its latest z14 mainframe system at the end of the third quarter of 2017. This mainframe refresh drove significant revenue growth in the second half of last year. In the fourth quarter, mainframe revenue soared 71% year over year, pushing total hardware revenue up 35%.
The z14 should continue to drive growth through the first half of 2018, although the growth rate will probably not be quite as impressive. Sales will then most likely slump in the second half as IBM laps the initial launch. This type of pattern is typical with each mainframe refresh as customers upgrade to the new system.
Beyond the mainframe, cloud computing will be another growth driver for the company. IBM's cloud business generated $17 billion of revenue in 2017, growing by 24% Cloud delivered as-a-service reached an exit run rate of $10.3 billion, up 20% year over year. Cloud computing is at the core of IBM's transformation, powering its ambitions in artificial intelligence, blockchain, and other areas. IBM's long-term model calls for as-a-service revenue to grow by 15% to 20% annually. It will need to keep up this growth rate to convince investors that its turnaround is the real deal.
Slow and steady
I don't expect anything surprising from IBM's report. The company will probably reiterate its guidance, which calls for revenue growth and flat earnings per share this year. Given IBM's large legacy businesses, don't expect anything other than sluggish growth overall.
One thing I do expect is for IBM to raise its dividend this month. The announcement typically comes about a week after the first-quarter report. Last year, IBM boosted the dividend by about 7%. A similar increase is likely this year, especially since earnings growth is taking a breather.
IBM has slowly and painstakingly positioned itself over the past five years to take advantage of growth markets like cloud computing, artificial intelligence, and security. With the company growing revenue again, a critical phase of that transformation is over. But IBM still has plenty of work left to do to reach its long-term targets and to prove to Wall Street that it's not being left behind.
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