Hewlett-Packard: Liquidity Analysis Paints A Bearish Picture

Mar.10.13 | About: HP Inc. (HPQ)

Hewlett-Packard (NYSE:HPQ) is in the midst of a turnaround that CEO Meg Whitman has talked about extensively. I know that HPQ has been winning the war against its long-time rival Dell (NASDAQ:DELL), and I did find HP to be undervalued, but let's take a look at the tech giant's liquidity.

When a firm has strong liquidity ratios, it portrays to an investor that it has the cash reserves to fund growth in the future. For a PC maker like HP that is looking to shift successfully to mobile, this is absolutely essential. But the liquidity numbers that I came across for HP are not very encouraging. Keep in mind, however, that this is just one of the many ways to analyze a stock.

A lot of the metrics that I have here for your convenience is paid material on other sites. For instance, stock research website YCharts requires you to be a Gold or Pro Platinum subscriber to get figures like the ones highlighted in this article that go back so many years. I've always wanted to ensure that investors got some value out of my articles and I hope this post accomplishes that to the fullest.

Liquidity analysis of a company involves looking at a class of financial metrics to determine a firm's capacity to pay off its short-term debt obligations. Typically, higher ratio values translate to a larger margin of safety for the firm to meet its short-term debts.

Click to enlarge images.

Click to enlarge

Source: HP annual reports and quarterly reports.

Current assets divided by current liabilities give you the liquidity ratio. HP's current ratio took a dive from 2010 to 2011. It has since improved, but has not reached the 2009 level. The liquidity ratio industry averages for 2012 are still being calculated and they may take another month to get updated. The HP fiscal year runs from Nov. 1 to Oct. 31 and this is the reason why its liquidity ratios for 2012 are listed here already. (I promise to put in the industry averages on the comments section to this article when they become available.) Anyway, it's safe for investors to assume that the 2012 industry averages will be higher than the HP values.

Cash and cash equivalents divided by current liabilities is the calculation used to obtain the quick ratio. The quick ratio is up from 2011, but it is still well below the 2009 level. The quick ratio has remained below the industry average throughout the five-year period analyzed here and the gap has gotten wider over the last two years -- a period that saw a steep decline in HP's stock price.

The cash ratio is obtained by dividing cash and cash equivalents by current liabilities. Even though the cash ratio has improved from 2011, it is again still lower than the 2009 level. Additionally, the comparison with the industry averages for the cash ratio tells pretty much the same story as the current ratio and the quick ratio comparisons.

Balance Sheet

Hewlett-Packard has a fairly strong balance sheet, as is shown in the table below. In 2012, HP reported $11.3 billion in cash and cash equivalents; it has been growing at an average of 3.42% over the last five years despite the three negative growth rates that can be seen in the table. The cash and cash equivalents and the financing receivables are the only ones in the asset column in the table that have seen steady growth.

The good thing is that the current liabilities have declined considerably, and this is an encouraging sign for value investors.

Click to enlarge

Note: U.S. dollar in millions.

Conclusion: Is HP a Safe Bet?

The liquidity ratios aren't the best and they are so far below the respective industry averages. The current low price of HP stock reflects this, as this risk is priced into the stock according to the efficient market hypothesis. Nonetheless, the current ratio is a tad above 1 and therefore there shouldn't be a problem meeting pressing debt obligations. Value investors will be happy to note that cash and cash equivalents are going up nicely with a corresponding decline in the current liabilities.

CEO Whitman has promised to cut costs (downsizing the workforce, etc.) and to look at lucrative business lines. These plans if accomplished should boost liquidity ratios going into the future. Investors probably aren't going to make gobs of money like they did with the Apple (NASDAQ:AAPL) bull run or the Google (NASDAQ:GOOG) stock uptrend, but HP still sounds like a good investment idea.

Disclosure: I am long HPQ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.