Dividend Aristocrats In Focus: International Business Machines - Sure Dividend

Sure Dividend

High-Quality Dividend Stocks, Long-Term Plan
The Sure Dividend Investing MethodMember's Area

Dividend Aristocrats In Focus: International Business Machines


Published on January 18th, 2022 by Felix Martinez

Every year, we review each of the Dividend Aristocrats, the exclusive group of companies in the S&P 500 Index with 25+ consecutive years of dividend increases.

This is a prestigious list of stocks, as the Dividend Aristocrats represent some of the strongest businesses in the world.

To become a Dividend Aristocrat, a company must possess durable competitive advantages and a steady business model that generates profits each year, even during recessions.

But it must also have a shareholder-friendly management team dedicated to maintaining consistent dividend increases each year.

We have compiled a list of all 65 Dividend Aristocrats, along with important financial metrics such as price-to-earnings ratios and dividend yields. You can download the full list by clicking on the link below:

 

For the 2021 Dividend Aristocrats In Focus series, first up is International Business Machines (IBM). Last year, IBM raised its dividend for the 26th year in a row.

IBM has struggled through a prolonged turnaround effort in the past few years. It has invested heavily in new areas such as artificial intelligence, data, and cloud services while attempting to return to growth.

These efforts have had mixed results. However, IBM has continued to raise its dividend each year.

With a high dividend yield near 5% and consistent dividend increases each year, IBM stock could be viewed favorably by income investors.

Business Overview

IBM is a global information technology company that provides integrated enterprise solutions for software, hardware, and services.

In the services business, IBM is the world’s largest IT provider with a 5.5% market share. In software, IBM’s software business is mostly middleware, which is the software layer that connects applications and devices to each other.

IBM sells the z15 mainframes, storage, and Power-based servers in hardware. The company has five business segments: Cloud & Cognitive Software, Global Business Services, Global Technology Services, Systems, and Global Financing.

On October 20th, IBM reported third-quarter financial results. For the third quarter, the revenue of $17.6 billion increased 0.3% year-over-year, or down 0.2%, adjusting divested businesses and currency fluctuations.

Total cloud revenue over the last 12 months of $27.8 billion was up 14% (or 11% adjusting for divested businesses and currency fluctuations).

Source: Investor Presentation

Higher expenses and a higher share count resulted in lower earnings-per-share from continuing operations. This figure declined 33.9% from the same quarter in 2020.

For the first nine months, revenue of $54.1 billion increased 1.6% adjusting for divested businesses and currency. Diluted earnings-per-share from continuing operations was $3.77 compared to $4.72 in 2020, a decline of 20%.

IBM’s disappointing EPS performance was due largely to a loss of $2.85 per-share impact for charges.

These charges include amortization of purchased intangible assets and other acquisition-related charges, retirement-related charges, U.S. tax reform enactment impacts, and transaction costs associated with the Kyndryl separation.

Meanwhile, IBM’s revenue increase was slight, but an indication that the company’s turnaround may finally give way to growth in 2022.

Growth Prospects

IBM’s headline numbers look fairly weak, given the slow growth in revenue and a decline in earnings-per-share. But underneath the surface, there are signs emerging that IBM’s turnaround is gaining traction.

Its strategic imperative is to become a leader in artificial intelligence and hybrid cloud solutions. It has invested aggressively in these areas, such as the $34 billion acquisition of Red Hat in 2019.

IBM sees the hybrid cloud as a $1 trillion market, and its biggest opportunity to return to growth in the future.

It plans to accelerate client adoption of hybrid cloud and AI. This would help deliver innovation and help enhance its portfolio.

Source: Investor Presentation

Some of these initiatives are already showing positive results.

In the 2021 third quarter, IBM’s total cloud revenue increased 14% over the last 12 months adjusted for divested businesses and currency, reaching $27.8 billion. Red Hat revenue increased 17% for the third quarter.

The core Cloud & Cognitive Software segment saw 2% growth in Cloud & Data Platforms, led by Red Hat. For the nine months, IBM’s total cloud revenue rose 4.2%, exceeding $17 billion.

As growth areas such as the cloud become a larger portion of IBM’s overall revenue, there is hope that the company will return to growth. IBM management expects to grow revenue for the full year 2022.

It also expects adjusted free cash flow of $11 billion to $12 billion in 2022. This would represent growth from 2021.

We expect 4% annual EPS growth for IBM over the next five years. This forecast takes into account modest revenue growth, as well as share repurchases.

IBM ended the third quarter with $8.4 billion of cash on hand. This is down $5.9 billion from year-end 2020 reflecting acquisitions of $3.0 billion and debt reduction.

Competitive Advantages & Recession Performance

Despite its lack of growth in the past few years, IBM still enjoys meaningful competitive advantages.

Specifically, it has industry leadership position and scale.

Holding such strong positions in its core strategic areas gives IBM a better chance of successfully returning to growth.

In terms of recession performance, IBM receives mixed reviews. As a global technology company, IBM is exposed to the fluctuations of the broader economy.

For example, in 2020 the company’s revenue and earnings-per-share declined as the global economy fell into recession due to the coronavirus pandemic.

That said, IBM performed relatively well in the Great Recession of 2007. IBM’s performance during that recession is listed below:

It is quite impressive that IBM was able to grow its earnings-per-share in each year of the Great Recession. Moreover, the dividend kept increasing as well.

While the company’s recession performance was not as strong in 2020, it did remain highly profitable, which allowed it to keep its dividend increase streak alive.

Valuation & Expected Returns

IBM shares look attractive on a valuation basis, as the stock trades for a price-to-earnings ratio of 12.3 based on 2022 EPS from continuing operations of $10.84.

Investors should also keep in mind that EPS is coming off a low base from 2020. Even so, the stock trades above our fair value P/E estimate of 11. The impact of a declining valuation multiple could reduce annual returns by 2.3% per year over the next five years.

These negative returns could be offset by earnings-per-share growth and dividends. As previously mentioned, we expect 4% annual EPS growth through 2026.

In addition, the stock has a high current dividend yield of 4.9%. Overall, we estimate total returns at 6.5% per year.

This is a decent, albeit modest, expected rate of return. Therefore, we rate the stock a hold. However, IBM could be an attractive stock specifically for income investors in search of high yields.

We believe the dividend is safe, given the company’s strong cash flow generation.

Final Thoughts

In 2021, IBM was inducted to the prestigious Dividend Aristocrats list, but investors may not have noticed due to the company’s ongoing fundamental difficulties.

But despite the persistent decline in revenue over the past few years, IBM has continued to raise its dividend each year, due to its steady profitability and strong free cash flow.

IBM’s performance is improving, and the company is deleveraging.

The separation of Kyndryl will alter IBM as it becomes more of a software and consulting company rather than a services company. This should benefit IBM as software sales are higher-margin.

With a high dividend yield of 4.9%, and a rising dividend each year, we view IBM stock as a hold for income investors.

If you are interested in finding high-quality dividend growth stocks suitable for long-term investment, the following Sure Dividend databases will be useful:

The major domestic stock market indices are another solid resource for finding investment ideas. Sure Dividend compiles the following stock market databases and updates them monthly:

Thanks for reading this article. Please send any feedback, corrections, or questions to support@suredividend.com.


More from sure dividend
The Sure Dividend Investing MethodMember's Area