IBM is facing tough digital-transformation comps, and decelerations in Red Hat and consulting looks increasingly likely, wrote UBS analyst David Vogt.
David Paul Morris/Bloomberg
International Business Machines stock is coming under selling pressure on Tuesday after UBS analyst David Vogt cut his rating on the stock to Sell from Neutral, asserting that the Street has become too bullish on the company’s turnaround story.
Vogt trimmed his price target on IBM (ticker: IBM) to $124 from $136.
IBM CEO Arvind Krishna has been working to return IBM to growth, among other things spinning off its managed-services business Kyndryl (KD) to shareholders. IBM expects to report mid-single-digit top-line growth starting in 2022.
But Vogt thinks the market has already priced in the turnaround. He writes in a research note that the stock is now trading at more than 14 times his forecast on pro forma next-12-months profits of $9.47 a share, above its average valuation over both the last three- and five-year periods. Vogt contends that current valuation suggests the market is pricing in 2022 and 2023 earnings estimates 10% higher than his current estimates. He also says that IBM’s multiple has benefited from a rotation from growth into value, “creating risk.” And he sees risk to fourth-quarter results.
Vogt says some valuation expansion was expected post the Kyndryl spin, but he sees potential for substantial downside if the stock reverts to trading at 10 times revenue. He sees growth of 3.4% this year and 3.1% next year, which is below IBM’s mid-single-digit range. Vogt says that about 50% of IBM’s revenue—software aside from Red Hat and infrastructure—faces “secular headwinds” and is unlikely to grow long term.
“Given industrywide tough digital-transformation comps, a deceleration at Red Hat and consulting in 2022 also looks increasingly likely,” he writes. And Vogt says that the company’s reinvestment opportunities are hindered by its $6 billion in annual dividend payments, about half of expected free cash flow over the next three years. IBM has an annual dividend yield of 4.9%.
Vogt says his new price target is 11 times his 2023 estimate for pro forma profit of $11.25 a share, about 10% below his $12.55 estimate before the Kyndryl spin. For the fourth quarter, he’s estimating pro forma profit of $16.3 billion and $3.22 a share, which is down from his pre-spin estimate for $20.9 billion and $3.90. He notes that his cut of 68 cents a shares is more than the 45-50 cents a share implied from the Kyndryl spin, as he trims estimates on both hardware and consulting margins.
Though yesterday, IBM stock has rallied about 17% since Barron’s positively reviewed the company in a cover story in late November. In Tuesday morning trading, the stock is off 4% to $129.46.
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