Analysts React To IBM's Q2; Report 'Helps Put In A Valuation Floor,' Says Morgan Stanley

IBM IBM reported second-quarter earnings Wednesday, narrowly beating consensus estimates for both EPS and sales.

Investors responded positively for the most part, though some commentators did express concerns about the details. 

The Analysts

• Morgan Stanley’s Katy Huberty maintained an Overweight rating on IBM and cut the price target from $198 to $185.
• Stifel Nicolaus analyst David Grossman maintained a Buy rating and cut the price target from $182 to $178.
• Ittai Kidron of Oppenheimer reiterated a Perform rating without a price target.
• Wedbush analyst Moshe Katri reiterated a Neutral rating and $185 price target.

The Sell-Side Reaction

The consensus on the street seems to be that while IBM’s earnings were impressive, the headline figures overshadow potentially concerning sources.

"A relatively clean Q2 beat helps put in a valuation floor," said Morgan Stanley's Huberty.

While revenue growth in most regions is stabilizing and other factors point to sustainable progress, cognitive revenue declined, the analyst said. Q3 is expected to be tough for the segment, and Morgan Stanley is looking to Q4 for a return to growth.

Oppenheimer's Kidron made similar comments. “Despite the strongest top-line results in years, the source of the strength [systems and forex tailwinds] and weakness in cognitive give us reason to maintain our view … we remain on the sidelines.”

Wedbush's Katri highlighted structural headwinds in the software and services segments. IBM’s aggressive M&A activity has put a ding in free cash flow generation and profitability so far, although it will supposedly help support IT services in the future, the analyst said. 

Capital expenditures are up $300 million on a year-over-year basis, reflecting the company’s increasing investment in cloud infrastructure.

A highlight, in the opinion of Stifel's Grossman, is that underlying growth in the cloud segment is even stronger than it appears. The mainframe cycle, which is expected to reverse next year, put an 80-basis point headwind on what turned out to be 18-percent growth over the past year.

Even with that factored in, it will likely take a few more quarters of consistent revenue growth and margin stability for investors to turn more positive.

Price Action

IBM shares were trading 3 percent higher in the high-$148 handle Thursday afternoon.

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