International Business Machines Corp (NYSE:IBM) was a growth stock, but today the main interest is the dividend yield. Currently, IBM yields over 5%. Very few stocks that are not REITs, MLPs, or BDCs, have a yield this high. Further, IBM recently raised the regular cash dividend for the 25th consecutive year making it a new Dividend Aristocrat. At a time when many companies are cutting or suspending their dividends this is a positive sign.
There are only about 65 Dividend Aristocrats at the moment making this a select group. IBM Corp is one of the few stocks with a yield this high but still decent dividend safety metrics. But still there is some risk as revenue has been declining for years and debt is up due to the RedHat acquisition. In addition, there is a new CEO, which adds some uncertainty. However, I view the stock as long-term buy for those seeking income and dividend growth.
Overview of IBM Corp
IBM Corp is a global information technology company that provides enterprise solutions for software, hardware, and services. IBM’s focus is large, multi-national customers and governments, for which it runs mission critical systems. In the services business, IBM is the world’s largest IT provider.
And in software, IBM’s software business is mostly middleware, which is the software layer that connects applications and devices to each other. In hardware, IBM sells the z15 mainframes, storage, and the Power-based servers. The company also has over 90% market share in mainframes. IBM is in the midst of major changes. The company recently bought RedHat for $34 billion and installed a new CEO. IBM generated annual revenue of ~$77B in 2019. IBM operates in very competitive market segments. Some competitors include Microsoft (MSFT), Amazon (AMZN), HP Inc (HPQ), Hewlett-Packard Enterprise (HPE), and others.
Selected Data for International Business Machine (NYSE)
|P/E Ratio (FWD)||11.3|
Source: Data from Seeking Alpha
IBM Dividend and Safety
For investors interested in income and dividend growth IBM Corp pays an annual forward dividend of $6.52 per share and is yielding approximately 5.2% as of this writing. The yield was over 6% in late-March and early-April at the nadir of COVID-19 induced stock market downturn. Still, the yield is good and much higher than the roughly 1.8% offered by the S&P 500 index. The yield is also much higher than some utility and telecom stocks that normally attract those seeking income. IBM’s trailing dividend safety metrics are fairly decent, which is unusual for stock with a yield greater than 5%.
From an earnings perspective, the dividend was safe in 2019. The payout ratio was about 50%. From a forward earnings perspective the payout ratio is still decent at about 59% based on the forward dividend and consensus 2020 earnings per share of $11.05. This is below my criterion of 65% and suggest that the dividend is safe even with depressed earnings due to COVID-19. Assuming earnings recover in 2021 the payout ratio should decline.
The dividend is also safe from the perspective of cash flow. In fiscal 2019, free cash flow was $12,484 million. The dividend required $5,707 million giving a dividend-to-FCF ratio of roughly 46%. This is below my threshold of 70%.
That said, COVID-19 will provide some headwinds to earnings and cash flow in 2020 and possibly into 2021. This will likely put some pressure on the dividend in 2020. But as global economies reopen then sales, earnings, and cash flow should recover.
The sore spot for IBM Corp’s dividend safety is debt. Debt surged due to the RedHat acquisition. Total core debt is about $42.8B offset by ~$14.3B in cash, cash equivalents, and securities at end of Q2 2020. The company also has about $21.9B in debt in its Global Financing segment. This is offset by receivables and is decreasing due to winding down of OEM financing. However, IBM generates high cash flow and is able to meet its obligations at this point.
IBM’s Competitive Advantage, Risks, and Valuation
IBM Corp’s competitive advantage is its brand, long-term customer relations, and large patent portfolio. In the near-term the company faces risks from COVID-19 negatively impacting revenue and earnings. Over the long-term IBM faces intense competition and many of its competitors have a head start in the cloud. IBM is probably slightly undervalued at the moment based on reduced consensus 2020 earnings of $11.05 per share. At the current stock price IBM trades at a forward price-to-earnings ratio of about 11.3. This is slightly below the trailing 10-year multiple of about 12X. It may be possible for income or dividend growth investors to buy IBM at reasonable valuation in an arguably overvalued market.
Disclosure: I am long IBM.
About The Author
Dividend Power is a blogger on dividend growth stocks and financial independence. Some of his writings can be found on Seeking Alpha, ValueWalk, The Money Show, Forbes, and leading financial blogs. He also works as a part-time freelance equity analyst with a leading newsletter on dividend stocks. He is currently in the top 10% out of over 7,575 financial bloggers as tracked by TipRanks (an independent analyst tracking site) for his articles on Seeking Alpha.