IBM Earnings- Buy the pullback

IBM's Q3 earnings report reflected a mixed performance, sending its stock down by 4.9% in premarket trading. The company posted adjusted EPS of $2.30, beating the consensus estimate of $2.23, but revenues fell slightly short at $14.97 billion, compared to the expected $15.07 billion. IBM's gross margin of 57.5% exceeded expectations, largely driven by strong performance in its higher-margin software business, which grew by nearly 10%.

The software segment delivered $6.52 billion in revenue, significantly above the expected $6.37 billion, marking a 9.7% year-over-year increase. However, consulting revenues were flat at $5.15 billion, missing estimates, as discretionary spending pauses impacted growth. Infrastructure revenue also disappointed, coming in at $3.04 billion, down 7% year-over-year, as the segment awaits a new mainframe cycle in 2025.

CEO Arvind Krishna highlighted IBM's growing momentum in artificial intelligence (AI), with the company’s AI book of business now surpassing $3 billion, an increase of $1 billion from the previous quarter. However, despite this growth, analysts noted that the impact of AI on IBM’s profit and loss remains unclear, with more concrete benefits expected in the coming quarters.

IBM reaffirmed its free cash flow guidance of over $12 billion for the full year but did not provide specific revenue growth guidance for FY 2025. The company anticipates Q4 constant currency revenue growth to remain consistent with Q3, with a slight headwind expected from currency fluctuations. Analysts are cautiously optimistic about FY 2025, with expectations for stronger growth driven by Red Hat and AI.

While IBM's consulting business struggled, its strong software performance and margin improvements have kept analysts like those at Evercore and Melius bullish. However, the slowdown in infrastructure revenues, attributed to the delayed mainframe cycle, contributed to lowered expectations for the remainder of 2024.

The market’s reaction was largely influenced by the disappointment in the consulting and infrastructure segments, despite the positives in software and AI. Analysts expect some potential profit-taking following IBM’s recent stock run, with concerns about consulting revenue growth and sustained strong performance in the coming quarters.

Patient investors should allow the stock to slide down to the 50-sma ($215) for a better entry.

Overall, IBM's results showcased its strength in software and AI, but the company faces headwinds in consulting and infrastructure, which will need to improve to drive stronger revenue growth in 2025. Analysts remain cautiously optimistic, reiterating that IBM’s strategic focus on AI and the upcoming mainframe cycle should help it achieve higher growth next year.