Earnings may finally turn positive in FY 2025 (CY 2024).
The losses at Kyndryl have been significant since the spin but I believe these fortunes are about to change this calendar year.
The one-time costs associated with the separation from IBM have been significant but are about to finally end in FY 2024 according to management. This will provide more transparency in their financial results. It is tough to gain investor interest when reporting annual losses of ($9.09) in FY 2022 and ($6.06) in FY 2023. However, I tend to find that my best returns come from these opportunities after I dig deeper and validate my thesis. Some prior successes - At Home in 2021/2022 and PXD/OXY in 2021/2022.
The progress the management team is making against their 3 A strategy is starting to improve their fortunes. Specifically in the near-term, gross margin is improving from the Account Initiative which is the plan of renegotiating and rescoping 40% of their contracts from 0% gross margin to 26% gross margin.
What makes up the one-time spin-off costs?
Below is a chart that outlines the company's reported one-time addbacks to derive adj pretax income.
There were large tax related charges, layoff costs (workforce rebalance), impairment charges, and several other one-time costs over the last few years. Management has stated that FY 2024 will be the end of spin related transitions charges.
My forecast of adjusted pretax income for FY 2024 is $173 million versus management's guidance of $140 million which are both materially better that the ($217) million adj pretax loss reported in FY 2023. My higher estimate was influenced by IBM's strong quarter (they still work together with some customers), and that management has raised their guidance twice already this year.
What is most important in FY25 and FY26 is the improvement in gross margin?
As discussed in a previous post, the Account's Initiative is really improving gross margin. I am forecasting that gross margin at the company will improve to 23% by FY 2027versus only 11% under IBM leadership.
What gives me confidence of including such significant improvements in gross margins in my forecast?
First their actual gross margin results post spin has improved from 11% to 16%. Second, they still have 67% of their focused accounts priced at o% gross margin which will be addressed upon renewal. Focused accounts accounted for 40% of revenue under IBM. Finally, 23% gross margin is still below the competitive benchmark of 30%. I will be focused on gross margin performance in quarterly results as a key metric of measuring progress of management's execution of the turnaround plan.
Earnings forecast thru FY 2027
Below is my long-range forecast for the business.
Gross margin progress is critical to my forecast in the near term. The negative impact from the Accounts Initiative on revenue is forecasted become less of a drag by FY 2026. Critical to long term sustainable results will come from the Alliance Initiative by generating incremental revenue from their expanded partners and broader TAM. In a prior post I discussed this in more detail.
Mangement has maintained that revenue growth will resume in 2026 so don't expect revenue growth in the near term but I am still projecting positive earnings of $.67/share in FY 2025.
Conclusion
The three key components to my forecast of $2.78/share by FY 2027
Onetime costs stop in FY 2024.
Revenue Growth begins in FY 2026.
Gross margin progress continues to improve.
In my next post I will frame my price targets by year.
Comments