The market was strong on Wednesday, following through from strength on Tuesday. As we have been noting consistently, the market is adjusting what moves it from the Fed and government to a time when it needs real results from companies as well as economic data improvements. This shift is crucial to understand and watch. Wednesday, we got a solid round of earnings and data with good numbers from Empire Manufacturing and the MBA Mortgage Index. Additionally, the Fed Beige Book was overall fairly bullish as it noted better retail spending and real estate improvements. Empire Manufacturing improved to 12.5, beating estimates in the 3.5-4.0 range. MBA Mortgage Index improved 11%, showing growth in mortgages.
Wednesday morning, we also got earnings from Bank of America (BAC). They came in at an EPS of 0.29 versus 0.26 expectations as well as $21.5B in revenue over the $21.2B expectations. The company still had large litigation losses, but they did benefit from a better mortgage banking results even as those originations slowed. The company also saw credit-loss provisions improve at $336M from $2.2B one-year prior. The stock is up nearly 3% in pre-market.
On the company news side, we will be focusing on General Motors today. We have not been as bullish on GM as we have been with Ford. We like Ford's value-to-market-share argument better than GM, but GM has been the better performer. The stock is up over 30% in the past twelve months, while Ford (F) has moved up just under 20%. The companies are valued pretty closely, with one major difference in that F is valued at only 40x FCF and GM is valued at nearly 100x FCF. For us, we like the FCF factor better in F. The company has had a busy month of news with the government ending their stake in the company, selling its remaining stake in Ally, and then today and yesterday's news:
- The company announced a $1.1B restructuring plan for 2014
- They also commented that they see modest global growth in 2014, improvement in China this year, and improvement in 2015 in Europe
- The company noted they could take "modest" market share
Today, we want to take a closer look at these figures/developments to see if they change our current Hold rating and $35 price target that we have for 2014. First off, the dividend is a great addition to the name. It attracts income investors back into the name that have stayed away during the troubling economic times. The company is offering a 0.30 dividend for the quarter. If that becomes the annual rate, we are looking at a dividend yield of 3%, which is very solid and will definitely attract a new class of investors. The question, though, is whether or not GM has an image issue for income investors. Most want long-term investments and remember the destruction of the stock/company just five years ago. When we look at any dividend name, we want to examine it for safety.
Right now, the company will need roughly $1.7B in cash to pay out an annual dividend at a 0.30 rate per quarter. Interestingly, the company only had $1.5B in FCF at the end of 2012. In the TTM, that number has dropped to $560M. The company is expected to be able to have more cash flow after retiring preferred shares. The company has plenty of cash on hand, but FCF is a bit of a red flag for us. We will be anxious to see how FCF is working after this preferred share retirement. The company definitely has enough FCF to pay it and other cash on hand, but the ratio is not strong, meaning dividend growth/consistency can be questioned.
Additionally, the company announced $1.1B in restructuring costs at a Deutsche Bank Global Auto Industry Conference today. The company noted that they would see restructuring costs in Europe offset their pretax earnings for this year with global sales expected to be about 2% to more than 85M vehicles. The restructuring costs are one-time costs, so they will have nice adjusted numbers all year. And the situation in Europe does look to be getting better. The company notes this is a transition year, and they do believe that they can see gains there by 2015 and breakeven in profits. The company's guidance, though, was a little soft as Paulo Santos notes:
As for revenue, General Motors guided towards a 2% gain for the year, whereas the present consensus called for 6.4%. As for earnings, this is what General Motors had to say (bold emphasis is mine):
DETROIT, Jan. 15, 2014 /PRNewswire/ -- General Motors Co. forecasts modest global industry growth in 2014 driven by the United States, China and Europe. Based on this outlook and the introduction of key vehicles globally, the company expects its total earnings before interest and tax (EBIT) adjusted to be modestly improved with improved underlying operating performance more than offsetting increased restructuring expense. Additionally, the company said it expects EBIT-adjusted margins will be similar to last year.
So basically General Motors is guiding towards slightly higher EPS, since it expects margins flat to slightly higher on 2% higher revenues. "Slightly higher" EPS would easily translate into 12% EPS gains just like I projected, instead of the 36% consensus prevailing then.
That would likely explain why the stock is down despite the dividend announcement, and additionally, shows that some of that was priced in. What it comes down to is that 2014 will be the last so-so year before what could be a giant year in 2015. The company will see more sputtering with green shoots in Europe and could make massive gains in 2015 as they open 4 new plants in China next year.
For us, it's still not yet the time to take the dive into GM. The company has some definite prospects this year for slightly better action in Europe, but a 2% overall volume increase is definitely a disappointment. Expectations are that revenue will increase 6%+ in 2014. The volume increase also likely will mean more compact and mid-size cars. We do not see a major push to return to SUVs that would push revenue a bit higher with a better mix. Even a slightly better mix cannot make the push to 6% revenue increase.
Shares should stay supported, though, because the prospects for 2015 are still solid, but this year looks like a flattish, transition year. And for now, we are going to pass.
In today's Deeper Look, we will be looking at Hewlett-Packard in 2014. Coming into today, we had a $23 price tag for 2013. The company outperformed a bit more than we expected, increasing 74%, but we liked the name for the Meg Whitman turnaround story (the same one we are seeing with Yahoo now), and the valuations were just way too weak to start the year. This year, though, the stock will need to start to perform.
We are updating our model to have a $36 price tag for 2014.
There are a lot of moving parts for HPQ right now, and the company has come a long way. Meg Whitman has done what was needed. She started to peel back the company's dependence on printing, personal computers, and storage. She invested heavily in the company's development of enterprise business with converged cloud offerings and new application and infrastructure software. Those developments have not paid off in overall organic revenue growth to this point, but Meg Whitman put it best in their Securities Analyst meeting:
So, if you pull the lens all the way back, this group of products and services and solutions is how I envision the HP transitions to growth. And while I believe, in the long-term, we are going to see a GDP like growth rate for HP, the reality is that, today, we have some declining businesses like traditional storage, like our business critical systems, home printing, our consumer PC business, and much of our licensed revenue from our software business. So, we have to manage that transition from declining businesses to these growing businesses that we are very excited about.
The company's shift to Enterprise is looking good, though. The company has had two developments that we are really bullish about. The first is the company's strategic relationship with Salesforce (CRM). The company is working to create a converged infrastructure that creates a holistic approach that combines hardware, software, and services to appeal to clients. It builds on the server business that HP uses along with the mew products that promote application/infrastructure IT. IN the relationship with CRM, the company will use HP's infrastructure hardware to enhance its data centers, offering a dedicated, complete service. Additionally, the company added DBI software to improve HP's own CRM services.
Here were comments from HPQ's Meg Whitman about what we can see in the coming year:
Converged infrastructure is our term and our leadership, and it is the backbone of the cloud. HP's converged cloud is a holistic approach that leverages the strength of HP's hardware, software, and services…in services; it's all about the next generation infrastructure. We are particularly excited about our next generation of blades, and of course Moonshot, our disruptive server offering. In storage, we have designed -- we have a platform designed for the 21st century, not the 20th century. With 3PAR, we have the most modern architecture, better common features from midrange to high-end, and the growth rates we are seeing here are tremendous. This is truly storage designed for the new style of IT.
And then in Software, there's HAVEn. This is HP's big data analytic platform, which is getting rave reviews. We are combining the best-of-breed in analytics, processing, and security to enable customers to truly realize the benefit of big data. In Enterprise Services, the new style of IT, it's all about the next generation of solutions to help our customers, as I said, get from where they are with their technology to where they must be. We have some great offerings in cloud, security, big data, application modernization, which everyone needs if they're going to move to the cloud, as well as mobility. Services help our customers exploit technology to help grow their businesses, increase agility, and manage risk.
The question, though, is can the company balance its declining weak businesses and promote its solid businesses to overcome it? As the company notes, it will be hard, requires excellent execution, and is still not yet there. After a 70%+ run in 2013 that could be an issue for the company in 2014 as far as more increases. Tablets, networking, and converged storage are very strong, while PC and printing will remain weak.
Further, the company announced they are reentering the phone market in India today. They are releasing two new phones/tablets in India this year. Additionally, China is expected to see strong demand. The resurgence of EMEA will also be very great. There are several other developments that we could see in 2014 that are interesting: the company has noted interest in 3D printing, acquiring new software companies to build out their enterprise business, and a potential rebound in notebooks.
Yet, the company's 2014 is really about continuing to grow its business outside of the PC and printer market. The company is entering a very crowded space, but they want to take strengths in hardware and work with companies that are the top in software like CRM. This path seems similar to what Oracle (ORCL) and IBM are doing, but in reality, the expectations are considerably low for the company. P/E is under 11 and future P/E is sub-8. Price/sales is still less than 0.5x, and the company has a measly 7.6x P/FCF. The stock is dirt cheap still even after 2013, and 2014 will be marked either by stabilization. A flat revenue year will actually be a big win.
Overall, we like what the company has done, but we need to start to see some real results and see that the company can manage these declining businesses and be strong in their growing businesses in 2014. Cloud, enterprise, and software need to show growth. PC flat and print weak will also be ideal. Even with all this, though, it's hard to expect much more than 3-4% growth in the coming years. PCs will not be coming back as they are expected to drop 5-10% in the next several years as tablets/mobile phones become stronger. HP does not have tremendous potential to exceed GDP with these declining/flattish businesses and very limited exposure to tablets/phones.
In our model, we are looking at 0 to -1% revenue growth in 2014. From there, we expect slow growth of 2-3% in 2015 with 3-4% growth in 2016 - 2018. The company has noted they expect to hit GDP like growth, and we are expecting the comeback to come into fruition in 2015. We are going with the company on this as they have done nearly everything at GDP levels since.
Tax Rate -
We assume a tax rate of 21-22% for the next five years.
We are expecting operating margins to grow to 7% in the next couple years before moving 8% from there. The margins are stronger in the enterprise sector, and the company will benefit from an improving operating structure. The visibility here is weak overall.
Capital expenditures are expected to increase as the company sees a cash conversion cycle move back to 21-22 days. We would expect CapEx to increase back to $3.7B and continue to increase to around the $4B area from there. The company will have to continue to invest in new companies and invest in their business with competition high and the market moving rapidly. For our model, we used an 8.5% cap rate, which is used for low-growth companies that should have cash flow discounted significantly.
When we use this we still come up with a $44 price tag. If HPQ can grow at 2-4% per year and obtain margins back at 8%, this stock is very undervalued still. The question is whether or not that is possible. In a scenario where the company sees no growth at all and 7% margins through 2018 the stock is still worth a mid-30s valuation. There is still a lot to like here.
The market continued its rebound on Wednesday with data giving another solid run to the market. Thursday, we expect more of the same action. If data and earnings are solid, we could breakout of 13500 area for the Dow Jones (DIA) and see another big day. Yet, we will start to see some consolidation at the 13600 area. Thursday is another important day of data with a key jobless claims report in the wake of the weak NFP last week. Additionally, we get CPI data, the Philly Fed Index, and NAHB Housing Market Index, which will be the first housing information of January. Additionally, we get a group of very important earnings reports. In the morning, we get reports from Citigroup (C), Goldman Sachs (GS), and UnitedHealth (UNH). The afternoon gives us American Express (AXP), Capital One (COF), and Intel (INTC). UNH will be interesting in the wake of the Affordable Care Act, while Intel has been on the move over the last several days and expected to have a very nice report. That report has a major impact on the Nasdaq (QQQ). Those reports will be crucial. Look for similar action in the S&P 500 (SPY) with a lot riding on this group of earnings as several are in the index.