Up 30% In Last Twelve Months, Will AI And Red Hat Power IBM’s Stock Higher Post Q2 Results?

Computing behemoth IBM (NYSE:IBM) is slated to report its Q2 2024 results in mid-July, reporting on a quarter that is likely to see the company’s sales decline, amid cooling IT spending. We expect revenue to come in at about $14.6 billion, a 6.6% decline compared to the last year, although this would be slightly ahead of the consensus estimates. We expect earnings to come in at $2.06 per share, slightly ahead of the consensus estimates and about 5% lower than last year.  So, what are some of the trends that are likely to drive IBM’s earnings?

We expect IBM’s core software operations to remain a key driver of the company’s performance. Over Q1, software sales grew by 5.5% to $5.9 billion, led by Red Hat – which has a large portfolio of open-source technology and hybrid cloud platform solutions, along with a large developer community.   We expect the trend to continue over Q2 as well. Separately, IBM has been looking to capitalize on the rising demand for artificial intelligence. While big tech titans such as Google and Microsoft focus on more generic large models geared toward the public, IBM is looking to help enterprise customers with customized AI models for their businesses. IBM’s Watsonx platform enables companies to train, tune, validate, and deploy customized AI models for their business applications while accounting for legal and regulatory concerns. A few months ago, IBM indicated that it has booked over $1 billion for its generative AI business since its inception, with the consulting side of the business seeing considerable gains as IBM guides customers on implementing AI-related software. IBM’s infrastructure business could see a more mixed quarter. While the company has been seeing growing demand for its IBM Z mainframes and Distributed Infrastructure, its infrastructure support business is seeing some headwinds.

The interest surrounding generative AI has resulted in IBM stock showing strong gains of 40% from levels of $125 in early January 2021 to around $175 now, vs. an increase of about 45% for the S&P 500 over this roughly 3-year period. In comparison, Arista Networks (NYSE:ANET), a company that also benefits from generative AI, has seen its stock surge by more than 300% over the same period. Arista is a market leader in high-speed networks catering to hyper-scalers and big corporations that are major stakeholders in the generative AI trend. Turns out, Arista is part of the 30-stock Trefis High Quality (HQ) Portfolio, which has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Now, can Intel’s stock fare better going forward?

At the current market price of about $176 per share, IBM stock trades at close to 19x consensus 2024 earnings. Although IBM’s growth rates have been lackluster, we think this is a fair valuation, given that IBM is focusing on core areas such as cloud computing, AI, and automation – which have strong growth prospects – after divesting its legacy business. IBM is also making mid-size acquisitions to bolster its portfolio of higher-margin software products. We value IBM stock at $180 per share, which is slightly ahead of the current market price.  See our analysis  IBM Valuation: Expensive or Cheap for more details on what’s driving our price estimate for IBM. Also, check out the analysis of IBM Revenue for more details on how IBM revenues are trending.

[1] Returns as of 7/4/2024
[2] Cumulative total returns since the end of 2016

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