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Hewlett Packard (HP) Is Not Dead March 18, 2013

Posted by Ishmael Chibvuri in Latest Articles!!!.
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…)

Hewlett Packard (HPQ) has undergone a precipitous decline in price over the past couple of years. One may wonder if Hewlett Packard is even a worthwhile investment after having disappointed investors over and over for the past decade. The company could add value from here, but as far as being a long-term investment, it falls short.

Qualitative Analysis

Source: Information pertaining to HPQ came from the shareholder annual report, shareholder quarterly report, Hewlett Packard Investor Presentation, along with YCharts.

Hewlett Packard has disappointed investors over the past couple of years based on the segment growth data. The revenue growth has declined in nearly every one of its categories.

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The revenue growth has declined by 6% year over year, which is a cause for concern. Analysts on a consensus basis anticipate the revenue growth to decline by 5.80% in 2013.

The main case for buying the stock is the fact that it is slightly undervalued. The company’s net income declined due to depreciation and amortization, which should not negatively affect the company’s cash inflows.

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The depreciation and amortization expense have remained fairly consistent up until 2011 and 2012. In 2011 the depreciation and amortization doubled the previous year’s. Then in 2012 the company reported $19.82 billion depreciation and amortization related expenses. Depreciation and amortization is basically where a company tells investors that the money they invested into equipment, patents, and etc. is worth less today than it was yesterday. It does not affect the company’s operations because it was money that was already spent. That being the case, the company must report depreciation as a part of a company’s expense due to generally accepted accounting standards.

The company’s cash flow is fairly stable. Hewlett Packard’s business portfolio is fully mature without any substantial growth opportunities. Predictable avenues of net income growth may involve share buybacks, cost cutting, and new product developments.

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The cash from operations have declined in recent years, no denying that. But the business itself was not so negatively affected that the company justified a $12 valuation. The company has undergone a period of restructuring, which should normalize forward earnings per share figures. Hewlett Packard will generate profit margins that are similar to its nearest competitor Dell (DELL).

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If we look closely at the above figure, Hewlett Packard’s Operating Margin was fairly stable and above Dell’s up until Q3 2011 (Depreciation and Amortization doubled). Following the 3rd Quarter, the company started reporting large Depreciation and Amortization expenses in between Q2-Q4 2012. These type of operating margins are likely to be extremely temporary. Furthermore, I anticipate Hewlett Packard’s operating margin to stabilize at a rate that’s similar to or above Dell’s operating margin of 5%.

If Hewlett Packard is able to stabilize revenue growth near 0%, generate a positive operating margin in the range of 5-8%, the stock will be able to generate reasonable returns for investors. I generally avoid commenting on turnaround stories, but this one is not that bad. I have to admit, the pessimism was really overplayed on Hewlett Packard.

Technical Analysis

Hewlett Packard has done awfully since 2010, and has been on a continuous decline for the past couple years. After hitting new all-time lows the stock has been able to bounce from $12. I don’t think this stock rally is a dead-cat bounce as the underlying fundamental factors of the business indicate otherwise. I believe that the stock was long overdue for an up-trend, which is something the markets are experiencing.

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Source: Chart from freestockcharts.com

The stock is trading above the 20-, 50- Day Moving Averages. The stock is below the 200-Day Moving Average. The stock has broken the upper trend line of the descending channel. The 20-Day Moving Average has crossed above the 50-Day Moving Average implying further strength in the up-trend. I anticipate the stock will appreciate over the long-term, and that the stock is in the beginning stages of a multi-year up-trend.

Notable support is $12.00, $16.00, and $20.00 per share. Notable resistance is $30.00, $36.00, and $40.00 per share.

Street Assessment

Analysts on a consensus basis have low expectations for the company going forward.

Growth Est HPQ Industry Sector S&P 500
Current Qtr. -17.30% -10.70% N/A 10.50%
Next Qtr. -16.00% 6.70% 1003.60% 16.20%
This Year -13.60% 4.00% 14.50% 8.10%
Next Year 1.70% 12.30% 32.80% 12.80%
Past 5 Years (per annum) 3.21% N/A N/A N/A
Next 5 Years (per annum) -0.82% 12.95% 17.68% 9.03%
Price/Earnings (avg. for comparison categories) 6.34 22.36 8.66 21.01
PEG Ratio (avg. for comparison categories) -7.73 0.61 1.25 2.16

Source: Table and data from Yahoo Finance

Analysts have low expectations, as analysts on a consensus basis have a 5-year average growth rate forecast of -.082% (based on the above table). This growth rate is below the industry average for the next 5-years (12.95%).

Earnings History 12-Apr 12-Jul 12-Oct 13-Jan
EPS Est 0.91 0.98 1.14 0.71
EPS Actual 0.98 1 1.16 0.82
Difference 0.07 0.02 0.02 0.11
Surprise % 7.70% 2.00% 1.80% 15.50%

Source: Table and data from Yahoo Finance

The average surprise percentage is 6.75% above analyst forecast earnings over the past four quarters (based on the above table).

Forecast and History

Year Basic EPS P/E Multiple
2003 $ 0.83 19.77
2004 $ 1.16 16.79
2005 $ 0.83 25.59
2006 $ 2.23 35.72
2007 $ 2.76 48
2008 $ 3.35 35.79
2009 $ 3.21 44.78
2010 $ 3.78 39.94
2011 $ 3.38 25.6
2012 $ (6.41) 13.63

Source: Data from YCharts

The EPS figure shows that throughout the 2003- 2010 period, the company was able to grow earnings. Throughout 2011 and 2012 earnings plummeted. The sudden decline in earnings was due to the depreciation and amortization expense, which did not have a substantiating impact on the company’s cash flow.

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Source: Data from YCharts

By observing the chart we can conclude that there are some structural problems in the company’s competitive and product environment. Meaning that if Hewlett Packard is able to stabilize operations while having a successful product launch in a new product category, the company could generate reasonable returns over a 5-year time span based on the forecast below.

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By 2018 I anticipate the company to generate $2.96 in earnings per share. This is because of product growth, improving global outlook, cost management and continued development overseas.

The forecast is proprietary, and below is a non-linear chart indicating the price of the stock over the next 5-years.

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Below is a price chart incorporating the past 10 years and the next 6 years. Detailing 16 years in pricing based on my forecast and price history on December 31st of each year.

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Source: Data from YCharts and price history is from Yahoo Finance.

Investment Strategy

HPQ currently trades at $22.18. I have a price forecast of $25.70 for December 31, 2013. The stock is currently trading below valuation, and should be bought on pull backs as a part of a shorter-term accumulation strategy.

Short Term

Over the next twelve to twenty-four months, the stock is likely to appreciate from $22.18 to $25.70 per share. This implies 15.87% upside from current levels. The technical analysis indicates a short-term up-trend. The previously mentioned price forecast using fundamental analysis further supports the assessment.

Investors should buy HPQ at $22.18 and sell at $25.70 in order to pocket short-term gains of 15.87% between 2013 and 2014.

Long Term

The company is a bad investment for the long-term. I anticipate HPQ to deliver upon the price and earnings forecast despite the risk factors (competition, regulation, economic environment). HPQ’s primary upside catalyst is international expansion, product development, share buy-backs, and cost management. I anticipate the company will deliver upon my forecasted price target of $31.59 by 2018. This implies a return of 62.17% (including dividends) by 2018. This is a bad return for a technology stock and it is likely that the stock will underperform the market.

Year Dividend Yield @ $22.18 per share Cumulative Total
2012 2.38 2.38
2013 2.60 2.60
2014 2.85 5.45
2015 3.11 8.56
2016 3.40 11.96
2017 3.72 15.68
2018 4.07 19.75

HPQ has a market capitalization of $43.1 billion; the added liquidity makes this an investment opportunity appropriate for larger institutions that require added liquidity. The risk is about average (1.1 beta).

Conclusion

Hewlett Packard is not dead yet, the personal computer has not become some legacy device no one is going to buy. Hewlett Packard could pack a reasonable punch to investors’ investment portfolios over the short-term, but over the long-term I’d look elsewhere to park the money.

The conclusion: Buy Hewlett Packard for short-term gains.

Source: http://seekingalpha.com/article/1280671-hewlett-packard-is-not-dead?source=email_investing_ideas&ifp=0

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