HP: Reasons To Be Bullish

Mar.25.14 | About: HP Inc. (HPQ)

Summary

Post Autonomy write down, HP remains undervalued.

The solutions are competitive in the consumer and enterprise segments.

The technicals are bullish.

Hewlett-Packard Co. (NYSE:HPQ) reported first-quarter results that topped my expectations. The quarter was highlighted by a stronger than expected PC market. Hopefully Meg Whitman and the rest of the HP crew are able to keep up the solid execution in the second quarter.

In my opinion, HP has been able to develop competitive product offerings. While the company may not have been the first to enter the tablet market, they are almost certainly going to make a large impact with their products. I think that impact will come at the expense of Apple (NASDAQ:AAPL), as the tablet market becomes commoditized. Also, HP offers an excellent all-around solution within the enterprise space. And the firm is still amongst the leaders in printing as it ramps its 3-D printing offerings during the back half of this calendar year. The sum of the parts suggests HP should have a relatively bright future.

Consequently, post Autonomy write down, HP remains 47% undervalued.

Recent Developments

  1. HP increased its regular dividend by 10.2% to 16 cents per share.
  2. Meg Whitman said that H-P is planning to enter the 3-D printing market in June.
  3. The 3-D printing market has grown by about 27 percent every year for the past three years.
  4. HP unveiled HP ConvergedSystem for SAP HANA, a portfolio of integrated systems that are purpose-built to deliver clients a fast path to value when using the SAP HANA platform.
  5. HP Autonomy launched Aurasma 3.0, which expands on the augmented reality platform by market it easier for customers and partners to build powerful AR experiences, segment and target content by audience and drive deeper integration with social media networks. Aurasma 3.0 is available in the Apple App Store and Google Play.

Business Summary

HP is a leading provider of products, technologies, software, solutions and services to individuals, consumers, small- and medium-sized businesses, and large enterprises, including customers in the government, health and education sectors. HP's operations are organized into seven reportable segments for financial reporting purposes: Personal Systems, Printing, the Enterprise Group, Enterprise Services, Software, HP Financial Services, and Corporate Investments.

For the year ending (in millions of dollars except per share data):

2011-10

2012-10

2013-10

2014-10E

2015-10E

Revenue

$127,245

$120,357

$112,298

$106,683

$109,883

Gross profit

$29,827

$27,972

$25,918

$24,537

$25,273

Adjusted operating income

$9,677

$6,978

$7,131

$7,468

$7,692

Adjusted net income

$7,074

$1,598

$5,113

$5,334

$5494

Adjusted diluted EPS

$3.32

$0.81

$2.62

$2.78

$2.90

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The company's first quarter results came in ahead of my forecast for the full year. Management is guiding towards GAAP diluted EPS of $2.85 to $3.00 while I'm forecasting EPS of $2.78. Still, I am maintaining my view of a roughly 5% Y/Y decline in revenue. I think that it will take another year, 2015, before HP's new competitive offerings make a significant impact on the market. Consequently, unless second quarter results come in well ahead of my expectations, I will maintain my forecast (minor tweaks are possible). Additionally, examples of HP's competitive offerings are the HP Moonshot, and the hybrids and tablets.

 

2011-10

2012-10

2013-10

2014-10E

2015-10E

Ending financial leverage

3.35

4.85

3.88

3.70

3.40

Cash ratio

0.16

0.24

0.27

0.29

0.32

Current ratio

1.01

1.09

1.11

1.13

1.15

Debt-to-capital

0.44

0.56

0.45

0.43

0.41

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The liquidity is ample and the solvency position is solid. Looking forward, I expected management to moderately decrease financial leverage. Additionally, the liquidity should continue to increase. HP could increase the amount of leverage outstanding but the firm is nearing the limit that shareholders would find tenable.

For the year ending (in millions of dollars):

2011-10

2012-10

2013-10

2014-10E

2015-10E

Cash provided by operations

$12,639

$10,571

$11,608

$10,668

$10,988

Capex

$4,539

$3,706

$3,199

$3,500

$4,000

FCFF

$8,649

$7,557

$8,900

$7,623

$7,383

FCFE

$17,706

$7,686

$2,967

$5,168

$3,988

Common stock repurchases

$10,117

$1,015

$1,105

$1,204

$1,313

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Cash flow from operations is expected to decline in fiscal 2014, which is inline with the revenue decline. I think capex will increase during the next couple fiscal years, but generally capex is roughly flat over the 5-years period. Free cash flow to equity is likely to be adversely impacted by capital returns to debt holders, and share repurchases could increase during the coming fiscal years. HP should continue to generate healthy free cash flow to the firm's providers of capital.

Additionally, HP's quality of earnings during fiscal 2013 was excellent, and the firm collected 100% of revenue in cash from its customers.

Granted HP faces headwinds in almost all, if not all, of its operating segments. But I think that the firm has some competitive offerings in the market. For example, do people really need a $500 iPad to visit Facebook, Seeking Alpha, and ESPN? Or can I use a $150 HP tablet? On the enterprise side, the techies are raving about the HP Moonshot. And last but not least, the firm will start ramping its 3-D printing offerings during this calendar year. Consequently, HP is likely to continue to generate a return on equity that is above its cost of equity.

Risks

  1. The share price is likely to remain volatile and investors could lose a portion or all of their investment.
  2. Investors should judge the suitability of an investment in HPQ in light of their own unique circumstances.
  3. A decline in the global economic growth rate and/or a decline in the pace of economic growth in the United States could adversely impact the results of operations and the share price.
  4. The technology industry is characterized by rapid technological change, which could materially adversely impact the results of operations.
  5. Competition in product development and pricing could adversely impact performance.
  6. Incorrect forecasts of customer demand could adversely impact the results of operations.
  7. Higher interest rates may reduce demand for HPQ's offerings and negatively impact the results of operations and the share price.

This section does not discuss all risks related to an investment in HPQ.

Portfolio & Valuation

Click to enlarge

HP is in a bull market of primary, intermediate, and minor degree. The share price is nearing a top, but honestly that top could end up being near $40 per share. Simply stated, bull can sit back in the chair and enjoy the ride.

Monthly expected return

Quarterly expected return

Monthly standard deviation of returns

1.15%

3.44%

10.34%

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Intrinsic value estimates

Forward price multiples based on base case scenario

Optimistic

$65.26

P/E: 16.78

Base case

$46.61

P/S: 0.84

Pessimistic

$23.31

P/BV: 3.23

   

P/CFO: 8.39

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The base case scenario suggests that HP is undervalued by 47%. In my opinion, the model used conservative estimates of the fundamentals. At $46 per share, HP would still be below its 2010 level. The share price probably won't appreciate 47% during this fiscal year, but if it did, HP would be trading at a not too taxing 17 times 2014 earnings.

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.