U.S. markets open in 5 hours 8 minutes

IBM Poised to Report Third Straight Quarter of Growth

Timothy Green, The Motley Fool

International Business Machines (NYSE: IBM) has now reported two consecutive quarters of revenue growth after a nearly six-year period of slumping sales. When the company reports its second-quarter results on July 18 after the market closes, investors will be looking for the century-old tech giant to keep that streak alive.

More growth ahead

Across 18 analysts, the average estimate for IBM's second-quarter revenue is $19.92 billion. That represents an increase of 3.2% year over year. A component of that growth will be related to changes in exchange rates. IBM has enjoyed a currency tailwind in the past two quarters that has boosted its revenue.

Also driving this growth will be IBM's growth businesses, which includes its cloud computing business. The growth businesses, what IBM calls "strategic imperatives," accounted for 47% of the company's revenue over the past year. That revenue expanded by 10% adjusted for currency in the first quarter.

The cloud business grew even faster, jumping 14% on a currency-adjusted basis. Trailing-twelve-month cloud revenue now sits at $17.7 billion, and cloud delivered as-a-service has reached an annual revenue run rate of $10.7 billion. IBM expects the as-a-service portion of its cloud business to be a long-term growth engine for the company.

A person working on an IBM z14 mainframe system.

The z14 mainframe. Image source: IBM.

The mainframe business will also play a role in IBM's second-quarter results. The latest z14 mainframe started shipping in the third quarter of last year, so IBM will still enjoy a hardware sales boost in the second quarter relative to the prior-year period. That tailwind will turn into a headwind in the second half as IBM laps the z14 launch.

IBM has announced a slew of major deals in the past couple of months, although it's unclear whether these will affect its second-quarter results. A $750 million agreement with the Australian Federal Government, a $500 million joint venture with an Italian bank, a $320 million deal with a Danish tech company, and a bunch of smaller cloud computing commitments from major European companies all tell a story about IBM's advantage when it comes to big, multi-technology deals.

Analysts are also expecting the bottom line to grow. The average estimate puts IBM's second-quarter adjusted earnings at $3.04 per share, up from $2.94 per share in the same period last year. That's a 3.4% bump, right in line with the expected revenue growth. IBM expects its full-year adjusted earnings per share to come in at $13.80 at a minimum, with analysts expecting $13.81 on average.

Will it be enough?

While IBM beat analyst estimates across the board when it reported its first-quarter results in April, the stock still declined the next day. Part of the problem was that IBM's revenue adjusted for currency was essentially flat. Another problem was a 0.7 percentage-point-decline in gross margin.

As IBM's legacy businesses have shed sales, replaced by growth in areas like cloud computing, analytics, and artificial intelligence, its margins have taken a beating. On a GAAP basis, IBM's gross margin in 2017 was down more than 4 percentage points from its peak in 2014. Likewise, operating margin was down more than 5 percentage points.

This trend should reverse as IBM's strategic imperatives continue to grow. Many of these growth businesses skew more heavily toward software than the rest of the company. That should have a positive effect on margins. But it hasn't flipped the script yet, and until it does, the market won't be convinced that IBM's turnaround is truly making progress.

If IBM can start moving margins in the right direction, the stock may finally break out of the doldrums. But another so-so quarter probably won't be enough.

More From The Motley Fool

Timothy Green owns shares of IBM. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.