Sirius Is Still Not A Buy, Can HP Move Higher? And Our Weekly Outlook

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 |  Includes: DIA, HPQ, LMCA, SIRI, SPY
by: David Ristau

Summary

The market is really only a three-day week with Thanksgiving on Thursday and many on Wall St. out on Friday, so we have a shortened period for the market to move, but we are packing a lot in the first three days of the week. The keys to the market this week will be housing data that will be released, November consumer confidence data, and the most-important day of retail in the year with Black Friday. Additionally, we have to continue watch for potential signs of a December Fed taper as well as key overseas developments as those markets continue to improve and show signs of green shoots.

Chart Overview

The S&P 500 (NYSEARCA:SPY) is breaking out of all resistance lines and looks solid right now over 1800, finishing the week creeping over the key 1800 line. We can expect more upside from here if the index can hold that level.

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The Dow Jones (NYSEARCA:DIA) is also looking to breakout over the 16000 level as it finished last week over the line. DIA has started to be very solid, but its first major support line is at around 15500, so if we do correct it could be a big reversal for DIA.

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Economic Data

Date

Data Report

Market Expectations

Previous Report

November 26

Housing Starts - Sept/Oct

915K/920K

891K/NA

November 26

Building Permits - Sept/Oct

932K/932K

918K/NA

November 26

Case-Shiller 20-City Index - September

13.0%

12.8%

November 26

FHFA Housing Price Index - September

N/A

0.3%

November 26

Consumer Confidence - November

72.4

71.2

November 27

Initial Claims - 11/23

330K

323K

November 27

Durable Orders - October

-2.2%

3.8%

November 27

Chicago PMI - November

58.0

65.9

November 27

Michigan Sentiment - November

73.0

72.0

November 27

Leading Indicators - October

-0.1%

0.7%

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As we can see from the economic calendar, there is a lot on the agenda for what is really just two days of action in the market. On Tuesday, the market will be getting a large group of residential construction news with Housing Starts, Building Permits, Case-Shiller Index, and FHFA Housing Price Index all on the agenda. Further, for starts and permits, we get both September and October numbers that should give a clearer picture of what is going on in these markets. These markets have been volatile as of recent, and this should help them out. On Wednesday, the market will get another large group of data points with initial jobless claims leading the way. Another positive report here could tip the market into more belief of taper coming. Chicago PMI and Michigan Sentiment are both November data points, so those will be crucial to the market as well.

Foreign Markets

Outside of the USA, Europe and Asia were important to the market last week, and they should continue to be quite important moving forward. Last week, both markets showed more positive signs, and they need to continue to show green shots. This week, the markets are a bit lighter overall. Some of the key reports this week include the German Gfk Consumer Confidence survey for December on Wednesday as well as Great Britain GDP for Q3. On Thursday, we get a large group of Japan bond buying as well as the Chinese Leading Index for October. Additionally, we get German Consumer Price Index, German Unemployment Rate, and Euro-Zone Consumer Confidence. Overall, it is not a giant week for these markets, but they will continue to play a key role in American markets if they continue to improve.

Earnings

Date

Key Company

November 25

SeaDrill (NYSE:SDRL)

November 25

PVH (NYSE:PVH)

November 25

Qihoo 360 Technology (NYSE:QIHU)

November 26

Tiffany (NYSE:TIF)

November 26

Hewlett-Packard (NYSE:HPQ)

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It is a very light week of earnings this week with the only real highlight being HPQ. The tech company needs a solid report to show some signs of a turnaround. Additionally, we get some interesting reports from Tiffany to get a look at luxury goods as well as QIHU to see how the Chinese Internet company is progressing in its quest to take down Baidu (NASDAQ:BIDU).

The key report for the week is HPQ, and the company could be a key portion of the move in the Nasdaq this week. The company has been searching for ways to recover from a declining amount of PC usage as well as their late arrival to the mobile movement. CEO Meg Whitman has been on the path to turnaround the company, but thus far, the results have been so-so (at best). The stock is up large this year at 81%, but the company is going to need to see some serious progress if shares are going to move higher. After its last report was disappointing, the stock dropped nearly 15%.

The issues are well documented. HPQ is largely dependent on revenue from personal computers and printing, and the company's tablet options have been not well received. In the last report, sales fell 8% from one-year prior while five out of six main business units saw revenue drops. Further, in the latest report, Whitman went back on previous ideas that the company would be able to grow revenue in 2014. The company cut 29K jobs as well as shook up management in the latest report, and shares have recovered all the way back to where they were before the last report, setting the company up for a very important report this week.

What's the key to watch with HPQ this week's earnings?

Expectations are for the company to report a drop in EPS from 1.16 to 1.00 as well as see nearly 7% decline in revenue again. Expectations have been lowered over the past thirty days overall. The key to us is to ignore the weak parts of the company that we know will continue to be weak - PCs and printing. The focus should be on the portions of the company that HPQ is attacking to provide a turnaround in their business. The places that the company is attempting to make new inroads include data for hospitals and health care, 3D printing, cloud computing, and software. The problem for HP is that the company has been a consumer-focused company for quite some time, and they may have to move into entirely new markets that they aren't experts in to make this turnaround work.

Some numbers/conversation to watch:

- The major deal with Cerner (NASDAQ:CERN) to improve performance for health care IT in data analytics. This deal, if going well, could be a sign of a major business for the company that would allow them to move in a whole new direction.

- The company announced that it is entering 3D printing in 2014. Details about whether it's consumer-focused or business-focused…and is it buying someone out to get involved as well.

- The company is teaming with Salesforce (NYSE:CRM) to launch the Superpod that will allow customers to have better cloud experience and will be powered by HP.

- How many business units lost money again in the latest quarter.

Overall, the market has really made for a push back up for HP and with the last three months showing some positive changes, some of that jump was necessary. Without some more delivery progress, though, shares could be headed back to the doghouse.

Fed Outlook

The Fed finally takes a backseat in the marketplace this week. With weeks of speeches, taper conversation, Yellen nomination, and more, the market has been going through a daily exercise of figuring out the Fed's next move. This week, we get no Fed speeches and a series of Fed Activity indices from Chicago, Richmond, and Dallas. The Fed should be more limited in its impact this week.

Conclusion

We are positive on the week as we see the combination of positive holiday spirit joining up with some potentially solid data for the market. Weak data will push taper concerns while very solid data could give the market some relief that the economy can back itself once QE leaves. The Black Friday numbers as well as housing data are the two keys though.

Deeper Look

Ticker: Sirius XM Radio (NASDAQ:SIRI)

It has been about a month since we last updated our opinion on SIRI. In our last article, it was just before earnings were to be released, and we warned investors/traders that a move down off the report was likely with SIRI overvalued and ahead of itself. We were right. The stock move down over 10% on the next couple days and has had trouble moving up since despite decent market conditions. The problem we noted for SIRI is that the company had overpriced itself, and that unless earnings were a home run, shares would drop. We also noted that we do like the SIRI business, but we believe that growth is priced in as well as earnings expansion. We want to update our thesis based on the past thirty days of developments.

In our argument for selling Sirius, we noted that we had a 12-month price target of roughly $4. Our main points for this were based on the following:

- 8-10% revenue growth per year through 2017

- 26-30% operating margin for each year through 2017

- The company has a lot of potential with their movement into cars and outfitting all cars with Sirius capabilities, which will then help secondary car markets also be SIRI compatible

- Profits were less important on the bottom-line than top-line acceleration as well as more users being added.

Let's take a look at the earnings and development over the past thirty days to see how the company is doing.

In the earnings report, the company noted the following:

- Revenue grew 11% (exceeding our 8-10% model)

- Operating margin was at 29.6%

- The company added 513K new subscribers, bringing the total to date to 1.7M

The aspect of the used car development being one of the biggest catalysts was discussed directly in the company's earnings call:

We have seen that our existing new car subscribers are turning over their vehicles sooner than what would have been predicted based on historical industry trends. As a result, our subscribers are migrating from one radio to another in a newer car. This trend picked up in the third quarter and is ahead of our expectations and this trend of faster turnover is good for the business long-term as it leads to increased opportunities for used car subscriptions, but we are now estimating self-pay net adds of approximately 1.5 million for 2013

It was a solid report, but the company did not hit 26M subscribers (the level we noted that they needed to push more upside post-earnings). After the report as well, the company is still looking at a 50+ P/E ratio. The company, though, does have another $2.4B of share repurchase capacity currently, which will brings shares outstanding from 6.2B to roughly 5.53B. That drop pushes P/E from 52.5 to 48.0, but as we can see still leaves the stock quite expensive.

Outside of earnings, the last thirty days have been pretty quiet. The company did some more share repurchases with Liberty Media (NASDAQ:LMCA) as well as completed an acquisition of a unit of Agero. The unit will allow Sirius to provide connected automotive services across multiple auto manufacturers. A neat change of business that utilizes SIRI satellites, but it is not a game changer.

Let's update our model to reflect recent developments:

Revenue - We are sticking with CAGR of 9% for Sirius moving forward.

Operating margin - This may end up being higher than we previously forecasted, and we are adjusting our range to 28-32% from 26-30% as the company is seeing higher profits on the operating side more quickly than we expected.

Taxes - A hot button issue in our last article. The company has not used NOLs yet to offset taxes, and we are not sure when they will. Therefore, we will stick with our previous system of a normal tax rate and decrease our discount rate to adjust for the NOLs. While the system is not perfect, it does have the same effect in our DCF analysis as putting tax rate at 0%, so it is being included. If you want to know more about WACC and compare the discount rate we use with 25% tax rate versus 0% tax rate and lower discount rate, message us as it's a whole separate article.

Here is the adjusted outlook:

Step 1.

Project operating income, taxes, depreciation, capex, and working capital for five years. Calculate cash flow available by taking operating income - taxes + depreciation - capital expenditures - working capital.

2013 Projections

2014 Projections

2015 Projections

2016 Projections

2017 Projections

Operating Income

1058

1203

1311

1442

1590

Taxes

2600

2725

2888

3080

3250

Depreciation

270

274

278

280

282

Capital Expendit.

-125

-140

-150

-160

-170

Working Capital

-200

-200

-200

-200

-200

Available Cash Flow

1139

1236

1311

1402

1505

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Step 2.

Calculate present value of available cash flow (PV factor of WACC * available cash flow). The PV factor of WACC is calculated by taking 1 / [(1 + WACC)^# of FY years away from current]. For example, 2016 would be 1 / [(1 + WACC)^4 (2016-2012). WACC for SIRI: 10.00%

2013

2014

2015

2016

2017

PV Factor of WACC

0.9091

0.8264

0.7513

0.6830

*

PV of Available Cash Flow

1035

1022

985

957

*

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Step 3.

For the fifth year, we calculate a residual calculation. Taking the fifth year available cash flow and dividing by the cap rate, which is calculated by WACC subtracting out residual growth rate, calculate this number. Cap Rate for SIRI: 5.0%

2017

Available Cash Flow

1505

Divided by Cap Rate

5.0%

Residual Value

30090

Multiply by 20167PV Factor

0.6830

PV of Residual Value

20552

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Step 4.

Calculate Equity Value - add PV of residual value, available cash flow PVs, current cash, and subtract debt:

Sum of Available Cash Flows

3999

PV of Residual Value

20552

Cash/Cash Equivalents

717

Interest Bearing Debt

3650

Equity Value

21618

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Step 5.

Divide equity value by shares outstanding:

Equity Value

21618

Shares Outstanding

5530

Price Target

$4

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The issue that remains for Sirius is that a lot of expectations are priced in already. The company is pricing in roughly around 9% growth per year with operating margins moving to around 32% over the next three to four years. The market is also already pricing in the share buyback and the fact that there are no taxes. The catalyst for Sirius to see higher prices lies in the ability to grow at a faster rate or push profitability at a faster rate. Right now, we have not seen anything to make us move outside of these assumptions as competition rises for in-car audio with iTunes Radio, Pandora, and other services. At the same time, we believe this is a great growth company and a product that many on our staff enjoy personally. Yet, as a stock, the company is priced correctly, and we therefore still cannot see a reason to buy.

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

Business relationship disclosure: I have no business relationship with any company whose stock is mentioned in this article. The Oxen Group is a team of analysts. This article was written by David Ristau, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.