IBM | Fundamental Analysis | LONG

International Business Machines turned in a positive direction after its first quarterly earnings report following the spinoff of Kyndryl Holdings. After regularly underperforming earnings growth in past quarters, the company delivered on its promise to deliver "single-digit" earnings growth.

The tech giant has endured years of struggle trying to transform itself into a cloud company, and it took nearly two years under CEO Arvind Krishna. Now that the company is more efficient, with a renewed focus, the question for investors is, can IBM outperform the market over the next few years?

IBM started its new future much stronger, reporting Q4 income from continuing operations of $16.7 billion. That figure, which sets off what is now Kyndryl's business from numbers from a year ago, was a 6.5 percent increase over the year-ago quarter. The software and consulting segments lead the way, increasing revenues by 8% and 13%, respectively, for the period. In addition, hybrid cloud revenue across all segments totaled $6.2 billion, up 16% from last year.

Further, in the earnings report, this led to the net income in Q4 of $2.3 billion, a 72% increase over last year's quarter. Expenses were down 25% to $6.6 billion, primarily due to lower sales and marketing expenses, as well as general and administrative expenses. Although the company paid $407 million in income taxes during the quarter, compared with $175 million in tax credits in Q4 2020, this did little to offset the savings in operating expenses.

IBM offered no estimates. However, for the fiscal year 2022, analysts are projecting a 6% increase in revenue and 24% consensus earnings growth, indicating a long-term continuation of Q4 performance.

IBM's free cash flow, on the other hand, reflects some adjustments given that Kyndryl is now out of the picture. IBM reported a free cash flow of $6.5 billion for the fiscal year 2021 or $7.9 billion excluding expenses related to the Kyndryl spinoff. That's significantly less than the $10.8 billion in free cash flow in 2020. It's also close to the $5.9 billion IBM spent on dividends in 2021.

Nonetheless, free cash flow should increase with earnings growth, and spinoff costs will be left behind. The company is projecting $35 billion in combined free cash flow between 2022 and 2024, slightly higher on average than before the spinoff. In addition, with a 4.8 percent yield and a 26-year history of payout increases, an annual dividend of $6.56 per share should continue to make IBM stock attractive to income investors.

In its 111-year history, IBM has transformed itself several times. Now that the company has spun off its former managed infrastructure business, it has become primarily a cloud company. The software and consulting segments combined, which accounted for about 70% of the company's Q4 revenue, accounted for much of the company's growth.

What's more, after buying Red Hat, the company became a leader in hybrid cloud, a cloud environment that allows public and private clouds to run seamlessly. IBM is far from the only company involved in the hybrid cloud. Nevertheless, Mordor Intelligence predicts a compound annual growth rate (CAGR) of 21% in this segment through 2026, raising the possibility that hybrid cloud will continue to drive significant revenue growth for IBM.

This broad-based growth contrasts sharply with the fourth quarter of 2020. All of the company's segments reported declining revenues this quarter, with the only double-digit growth coming from cloud revenue in the company's two segments. In addition, the segment that ran what is now Kyndryl accounted for 32% of the company's revenue at the time, not counting the infrastructure business, which is still owned by IBM.

Indeed, IBM still runs the infrastructure segment, which showed flat growth in the last quarter. But because that segment only accounts for 26% of the company's revenue, it didn't have as much of an impact on its financial performance, which contributes to IBM's reputation as a cloud company. Strong revenue growth in the software and consulting divisions more than offset weak infrastructure performance.

Although predicting the future may present unexpected challenges, IBM seems poised to outperform the market over the next few years. After the Kyndryl spinoff and significant growth in the software and consulting segments, IBM is growing again and must meet its revenue and cash flow projections.

Admittedly, some growth-seeking investors may continue to ignore IBM in favor of smaller, faster-growing technology stocks. Nevertheless, for shareholders looking for solid growth and a steady stream of earnings, IBM seems poised for a long-awaited comeback.