Hidden Weakness in IBM’s 12/21 Quarter (IBM)

The Kyndryl spin-off and selective add-backs of charges are masking a lack of growth

IBM was hailed for reporting non-GAAP EPS of $3.35 which beat forecasts by 6 cents. It further saw revenue top forecasts by $730 million in the quarter. We believe much of this was related to one-time items, misleading restructuring charges, and distortions from the spin-off of Kyndryl, all of which are unlikely to last.

We believe investors should have been disappointed by IBM’s EPS beating by only 6 cents given that there were several one-time benefits that have been ignored so far:

• IBM guided to a 17%-18% tax rate but came in at 14.2% in 4Q21 – that added 12 cents to adjusted EPS.

• Pension income jumped by $84 million y/y and added 9 cents.

• Advertising declined by $43 million y/y and added 4 cents.

• Stock compensation fell by $15 million y/y and added another 1 cent to EPS.

• For the full year, IBM picked up $26 million, or 2 cents, from cutting warranty and environmental accruals – some of that likely helped the 12/21 quarter.

• IBM had enjoyed falling bad debt reserves helping EPS during 2021, but that reversed in the 12/21 quarter and became a 2-cent headwind.

Just these short-term items added 25 cents to EPS in a quarter where IBM beat by only 6 cents. We expect many of these to reverse quickly. IBM already guided to a mid-high teens tax rate, its growth plans should require more advertising, and people like being paid so we believe stock compensation should rise too.

We believe the Kyndryl deal and IBM’s one-time charges are masking more problems that should concern investors regarding IBM’s earnings quality and sustainability of its growth.