IBM Is Making Mostly Smart Moves, but the Cloud Is a Looming Threat
May 5, 2014
Grazed from MorningStar. Author: Peter Wahlstrom.
IBM (IBM) has announced a 15.8% increase to its quarterly dividend to $1.10 from $0.95, which was slightly above our expectation of a 10% hike. With its 19th annual increase, IBM’s payout ratio ticks slightly above 25% and should bring the annual dividend payment to nearly $4.4 billion. There is no change to our $212 fair value estimate or wide moat rating based on the news, and as the firm prepares for its investor day in mid-May, we continue to believe that management’s capital allocation strategy will (even if indirectly) remain in focus…
As IBM becomes a more specialized, software-based service provider, we generally agree with the strategic bets that the firm is making, like its smarter planet, growth markets, business analytics, and cloud/data center initiatives. However, IBM is generating about $17 billion in free cash annually but spending $6 billion and $4 billion on research and development and capital expenditures, respectively, and we believe that many investors are hoping for these investments to result in more than low-single-digit top-line growth over the medium term…
At the meeting in a couple of weeks, we expect to hear how previous investments are gaining traction, more about IBM’s map for growth and the firm’s capital allocation plans. A fair portion of our valuation for IBM considers variables such as leverage, normalized earnings before interest, growth, and return on new invested capital. Based on what we hear at the meeting, it may help to decipher why a 16% increase in the annual dividend was appropriate. We agree that a firm should not invest if it can’t generate an adequate return on a particular project. However, with five-year average returns on invested capital in excess of 35%, some investors may be interested in the decision to commit to anything more than a nominal increase in the dividend, rather than the seeing the payout ratio push closer to 30% (which is what we assume four years from now)…
Read more from the source @ http://news.morningstar.com/articlenet/article.aspx?id=646201
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