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IBM Upside Appears Limited At Current Price

New initiatives continue to mitigate the decline in IBM’s core business, but we don’t see a margin of safety in the shares.


 IBM's (IBM) second-quarter fiscal 2016 results largely reflected the firm’s continued push into growth markets associated with “strategic imperatives” (analytics, cloud, mobile, security, and social related work). On a trailing 12-month basis, strategic imperatives accounted for 38% of IBM’s revenue, or $30.7 billion, ahead of the firm’s expected run rate. We think IBM will continue to push its strategic imperative agenda, utilizing mergers and acquisitions to achieve its medium-term strategic imperative revenue target of $40 billion by fiscal 2018. On the core, or legacy, side of the business, IBM’s revenue performance was largely in line with our flat-to-down expectations, signaling no overall change to the business' trajectory or our view of it. Brexit commentary was notably absent during management’s call, and the company does not believe it will have any material impact on its fiscal year. As a result, the firm reiterated its full-year EPS outlook of at least $13.50. We are maintaining our $145 fair value estimate and narrow economic moat rating. With the stock up significantly over the past six months, we think investors should seek a wider margin of safety before investing in the company.

For the quarter, reported revenue declined 2.8% year over year to $20.2 billion (fell 2.6% in constant currency). The cognitive solutions segment was the strongest business segment, with analytics and security helping revenue increase 4% year over year to $4.7 billion. Global business services performed well in digital-related practices; however, the firm is seeing price and profit pressure in legacy service lines, and management also noted some execution issues connected to larger-than-expected investment needs for client projects. We will diligently monitor these unfavorable developments as the firm aims to retain its top-flight IT services position.

Andrew Lange does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.