Bullish On Hewlett-Packard But Expecting Consolidation

| About: HP Inc. (HPQ)

The share price of Hewlett-Packard (NYSE:HPQ) is trading higher since the last time I wrote about the company back in September. Including the analysis in this report, I remain bullish on shares of HP, but there could be an extended period of sideways trading coming in the near future. The period of sideways trading would be a reflection of the firm's consolidated business stabilizing.

Looking forward, HP still faces headwinds from the PC market and server market. On the bright side, tablets are becoming more commoditized, and HP has strong offerings in this category. Further, HP's scale advantage and substantial cash balance are valuable assets.

But, management and myself expect revenue to decline in fiscal 2014. For fiscal 2015, right now, I expect flat to slightly down revenue with the back half being better than the first half. With that in mind, I'm bullish on HP, but I expect the share price to consolidate the gains since the end of 2012.

Recent Developments

  • IBM reported a mid-teens decline, relative to the year-ago period, in hardware revenue during the calendar third quarter of 2013 - this suggests HP could report a significant decline in hardware sales when it reports earnings later this quarter.

  • PC sales slid just under 9% compared to a year ago, according to Gartner. But U.S. sales rose 3.5%.

  • Google launched a new HP Chromebook for $279.
  • HP is attempting to monetize its mobile patents - if successful, HP is likely to return the excess cash to shareholders.

Fundamental Analysis And Valuations

Overall, HP is a company facing financial performance challenges with a valuation that was adversely impacted by write downs and secular challenges.

I adjusted the fiscal Q3 of 2012 to make it more comparable to fiscal Q3 of 2013. With that noted, the consolidated revenue decline of 8.2% was not matched by operating expense declines, which meant the operating margin contracted. A larger reduction in SG&A expenditures would have muted more of the impact of declining consolidated revenue. But this impact was partly offset by a decline in interest expense. The result was an income before tax decline of 11.8%, which is larger than the revenue decline of 8.2%. Diluted shares declined 1.2%.

In terms of the balance sheet, cash increased by about $4B since the end of the fiscal 2012 third quarter. The decline in accounts receivable was inline with the decline in revenue, but the decline in deferred revenue was larger than the revenue decline, on a relative basis. On the other hand, the net plant, property and equipment decline was smaller than the revenue decline, in percentage terms, but the decline in retained earnings and shareholders' equity was larger than the revenue decline. The balance sheet analysis suggest a neutral to bearish position.

HPQ Cash and Equivalents (Annual YoY Growth) Chart

HPQ Cash and Equivalents (Annual YoY Growth) data by YCharts

The increase in the cash balance suggests HP will probably use some of its cash for an acquisition(s) and share repurchases.

The fiscal 2013 results are roughly inline with my estimates. I expect revenue of about $110B, an operating margin of about 6% and a net income margin of about 4.5%. Additionally, I expect fiscal 2014 revenue of about $104.5B, which is slightly below management's guidance.

In terms of valuation, I maintain the intrinsic value estimate of $33.50 per share from the previous report.

Also, my perception is the market is underpricing the growth of HP as the recent headwinds are likely to be a medium-term phenomenon.

Looking forward, HP is well positioned to benefit from the commoditization of the tablet form factor as well as the multi-operating system ecosystem. But HP faces headwinds in the Server division stemming from the impact of cloud computing.

Portfolio Management

From a technical perspective, an intermediate term bull market may be beginning as part of a bull market of primary degree. Should the share price fail at the $27 level, we could be looking at a bear market of primary degree through time, which means we would not see a sharp decline in the share price.

HPQ Chart

HPQ data by YCharts

Since March 2009, the compound monthly return, excluding dividends, is -0.4%; the share price is below its March 2009 level on goodwill write downs and weakness in the PC market.

The return distribution, during the same period, was not leptokurtic, lacked tail risk, and was positively skewed.

A linear regression of the share price suggests that in 52 weeks the share price of HP will be lower than it is today.

The analysis from a portfolio perspective reveals what we already know. The market discounted developments that adversely impacted the valuations of HP. Looking forward, there could be an extended period of sideways trading following the rebound from the 2012 low.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.