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IBM: New Mainframes, ‘Hybrid IT’ Promise Year of Outperformance, Says RBC

IBM's new mainframe, the "z14," should bring the kinds of stock performance of past mainframe cycles, writes Amit Daryanani of RBC, and is just one nice "lever" for IBM in 2018, others being the rise of "hybrid IT" spending that could play to IBM's strengths.

2017 was the year International Business Machines (IBM) had to deal with the disappointment of Warren Buffett, but 2018 could be much better, according to a report from RBC Capital’s Amit Daryanani, whothis morning raised his rating on the shares to Outperform from Sector Perform.

Daryanani raised his price target to $180 from $160, writing that revenue growth and margins will pick up in 2018, making it a "year of outperformance."

IBM stock is up $5.30, or 3.4%, AT $159.55,

Amor the things helping IBM this year, in particular Daryanani cites a “new mainframe cycle” for IBM’s “System Z” machines, and the rise of “hybrid IT” spending, where computing is split between cloud computing and a company’s own data center facilities.

On the first score, IBM’s “z14” mainframe is the first machine since the predecessor z13 in 2015, and was announced last July and started shipping in September.

He notes that IBM during the last five cycles saw “a cycle peak during the first full quarter of availability post product launch (consistent with management commentary)."

“Given this, IBM should see the largest benefit from the z14 cycle during the December/March quarters,” he reckons, as mainframe sales lead to “revenue tailwinds,” writes Daryanani, “three to four quarters following a product announcement."

Note that the outperformance of IBM stock starts to wain, on average, 270 days after the original announcement. So, Daryanani is also looking to other “levers” for IBM this year.

He sees a rise of hybrid IT spending as a potential lever. “We have seen a host of companies that are levered to on-premise solutions see an improvement in their underlying demand trends,” writes Daryanani, including NetApp (NTAP), VMware (VMW), and Red Hat (RHT).

“We expect this trend to remain intact through 2018 and given IBM’s position as a key enabler for hybrid IT, for large enterprise, the company should at least see revenue growth in line to modestly below IT spend patterns (~1-3% growth potential)."

Lastly, IBM’s gross profit margin may improve in 2018. He notes that the “strategic imperatives” revenue, including things such as cloud computing, is now past some of the “large investments” that held back margins in 2017. “We think 2018 could be the year where we see gross margins being stable to up modestly, year over year."