Is Hewlett-Packard A Better Buy Than This Tech Rival?

Jul.22.14 | About: HP Inc. (HPQ)

Summary

We pitch two companies from the technology sector, HP and Accenture, against one another in the latest installment of our Head-To-Head series.

The article focuses on the relative strengths and weaknesses of HP and Accenture based on business performance and sustainability/dividends/forecasts.

It ends with discussion of the current valuations of the two companies, and details whether HP represents good relative value at current price levels.

Hewlett-Packard Background

HP (NYSE:HPQ) was founded in 1939 and is headquartered in Palo Alto, California. It provides products, technologies, software, solutions, and services to individual consumers, small-and medium-sized businesses (SMBs), and large enterprises, including customers in the government, health, and education sectors worldwide. Its Personal Systems segment offers commercial personal computers (PCs), consumer PCs and workstations for the commercial and consumer markets. The company's Printing segment offers consumer and commercial printer hardware. Its Enterprise Group segment provides industry standard servers; business critical systems, as well as traditional and converged storage solutions. HP's Enterprise Services segment offers technology consulting and outsourcing, while its Software segment provides enterprise information management solutions, such as data analytics for structured and unstructured data.

Team Money Research Rating

Our investment philosophy is to focus on company fundamentals and identify stocks that are displaying strong business performance, that operate sustainably and that pay a decent, well-covered dividend.

We analyze each company relative to the other on the following criteria within each of our two main buckets:

Business Performance

  1. Return on equity
  2. Return on assets
  3. Operating margins
  4. Quarterly revenue growth
  5. Quarterly earnings growth

Sustainability/Dividends/Forecasts

  1. Debt to equity ratio
  2. Interest cover
  3. Dividend payout ratio
  4. Forward yield
  5. Annual EPS growth forecast

Once we have analyzed the two companies based on the first two buckets, we can then assess whether they represent good value based on the current prices of the two stocks. We use the following criteria to assess valuations on a relative basis.

Valuation

  1. Forward price to earnings ratio
  2. Price to book value ratio
  3. Enterprise value to EBITDA
  4. Price to 3 year average free cash flow ratio
  5. 5 year price to earnings growth ratio

So, for example, a company that performs well compared to its rival on the first two buckets (business performance and sustainability/dividends/forecasts) and that is undervalued relative to its peer (based on the third bucket: valuation) could outperform its competitor going forward.

The table below provides the data that we will use to analyze HP and Accenture (NYSE:ACN) for the first two buckets.

Stock

HP

Accenture

Business Performance

Return on equity

20.95%

52.58%

Return on assets

5.13%

15.61%

Operating margins

7.71%

14.29%

Quarterly rev. growth

-1.00%

7.50%

Quarterly EPS growth

18.20%

0.90%

Sustainability/Dividends/Forecast

Debt to equity ratio

79.41%

0.43%

Interest cover

N/A

275.11

Dividend payout ratio

20.00%

42.00%

Forward dividend yield

1.90%

2.20%

Annual EPS growth forecast

5.39%

8.83%

Click to enlarge

The results from our first two buckets show that HP is fairly evenly matched by Accenture. For example, both companies have very comfortable amounts of balance sheet risk, with HP having a net interest income (hence the 'N/A' for interest cover) and being well-shielded from interest rises, while Accenture has very low levels of debt, as highlighted by its debt to equity ratio of just 0.43%. Furthermore, both companies pay similar yields (1.90% for HP and 2.20% for Accenture) although we feel that there is more scope for HP to increase its dividend due to its lower payout ratio of 20% (versus 42% for Accenture).

However, where HP loses out to Accenture is in terms of profitability. Sure, HP scores well in terms of return on equity, return on assets and operating margins. However, its scores are easily outmatched by Accenture, which has a return on equity of 52.58% for instance. This is highly impressive - especially when Accenture has such low levels of debt on its balance sheet.

In terms of growth, both companies are forecast to increase the bottom-line at a respectable pace, with HP being edged out by Accenture as the former is forecast to increase EPS by 5.39% next year, and the latter is expected to increase it by 8.83%. As a result, we feel that Accenture fares slightly better in terms of the sustainability/dividends/forecast bucket and, when combined with its strong profitability (as shown in the first bucket: business performance), we think that HP is edged into second place by Accenture.

Overall, these are strong scores for both companies, but we feel Accenture is the better performer in the first two buckets.

Valuation

Due to its outperformance of HP in the first two buckets, we would expect Accenture to trade at a slight premium. Let's see if it does.

Stock

HP

Accenture

Valuation

Forward price to earnings ratio

8.82

16.17

Price to book ratio

2.32

8.98

EV/EBITDA

5.55

10.22

PEG

2.03

1.52

Price to free cash flow ratio

8.26

15.33

Click to enlarge

While we feel that Accenture deserves to trade at a premium to HP, we believe the current premium is too high. For example, HP's forward P/E is 45% less than Accenture's, while its EV/EBITDA ratio is 46% lower than that of its sector peer. Indeed, it's a similar story with regard to the two companies' price to free cash flow ratios, where HP also trades at a discount of 46% to Accenture. In fact, it is only the PEG ratio in which Accenture represents better value for money than HP, with the former having a PEG ratio of 1.52 and the latter having a PEG ratio of 2.03. So, while we feel Accenture does deserve to trade at a premium to HP, we think the premium is currently too wide and, as such, we believe that HP could outperform Accenture going forward.

Conclusion

HP is a high quality company that posted impressive scores on The Team Money Research Rating System. Although its scores were not quite on a par with sector peer, Accenture, the valuation bucket highlighted that the company appears to offer significantly better value for money at current price levels. As a result, we believe that HP could outperform Accenture going forward.

Don't forget to follow Team Money Research and let us know which stocks you'd like to see go head-to-head against HP in future articles!

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.