Why Hewlett-Packard Stock Is Still A Good Investment Opportunity

Aug.24.14 | About: HP Inc. (HPQ)

Summary

HP's turnaround has started to show encouraging results.

HP will continue to benefit from the increasing demand for PCs and share gaining in this market.

HPQ’s stock is ranked second among all S&P 500 tech stocks, according to Portfolio123’s "All-Stars: Piotroski" powerful ranking system.

Hewlett-Packard (NYSE:HPQ) turnaround has started to show encouraging results. The company reported third-quarter net revenue of $27.6 billion, up 1% from the prior-year period, its first year-over-year revenue gain in three years. HPQ's stock has surged strongly since the start of 2013. In fact, its relative strength index (RSI) technical indicator is indicating overbought conditions. Since the beginning of 2013, HPQ's stock has gained an astounding 158%. Nevertheless, in my opinion, HPQ's stock still has room to move up. HP will continue to benefit from the increasing demand for PCs and share gaining in this market. The company has compelling valuation metrics; its EV/EBITDA ratio is extremely low at 5.63, and it is generating much cash; its ttm price to free cash flow of 10.34 is very low. In addition, the company continued to deliver large sums of cash back to shareholders, in the form of share repurchases and dividends.

The Company

Hewlett-Packard provides personal computers, printers, enterprise server and storage technology, software, and a wide range of related products and services to individual and enterprise customers worldwide. The company was founded in 1939 and is headquartered in Palo Alto, California.

Valuation Metrics

The table below presents the valuation metrics of HPQ, the data were taken from Yahoo Finance and finviz.com.

Hewlett-Packard's valuation metrics are very good; the forward P/E is very low at 9.34, the Enterprise Value/EBITDA ratio is extremely low at 5.63, and the price-to-sales ratio is also very low at 0.59.

Latest Quarter Results

On August 20, Hewlett-Packard reported its third-quarter fiscal 2014 financial results, which was in line with EPS expectations and slightly beat Street's consensus on revenues.

Third-Quarter Highlights

  • Third-quarter net revenue of $27.6 billion, up 1% from the prior-year period and up 1% on a constant-currency basis
  • Third-quarter non-GAAP diluted net earnings per share of $0.89, up 3% from the prior-year period, versus the previously provided outlook of $0.86 to $0.90 per share
  • Third-quarter GAAP diluted net earnings per share of $0.52, down 27% from the prior-year period, versus the previously provided outlook of $0.59 to $0.63 per share
  • Third-quarter cash flow from operations of $3.6 billion, up 36% from the prior-year period
  • Returned $881 million to shareholders in the form of share repurchases and dividends in the third quarter
  • Operating company net cash of $4.9 billion, a sequential improvement of $2.2 billion

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Source: Q3 2014 Results presentation

In the report, Meg Whitman, president and chief executive officer said:

Overall, I'm very pleased with the progress we've made. When I look at the way the business is performing, the pipeline of innovation and the daily feedback that I receive from our customers and partners, my confidence in the turnaround grows stronger.

Dividend and Share Repurchase

Hewlett-Packard has been paying dividends since 1965. The forward annual dividend yield is at 1.73% and the payout ratio is only 24.8%. The annual rate of dividend growth over the past three years was very high at 20.1%, over the past five years was also high at 11.6%, and over the past ten years was at 5.6%. I consider that besides dividend yield, the consistency and the rate of raising dividend payments are the most crucial factors for dividend-seeking investors, and HPQ's performance has been very good in this respect.

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Source: Charles Schwab

Hewlett-Packard generated $3.6 billion in cash flow from operations in the third quarter, up 36% from the prior-year period. The company returned $881 million to shareholders in the form of share repurchases and dividends in the third quarter.

Since Hewlett-Packard is generating much free cash flow and the payout ratio is very low, I believe that the company is well-positioned to achieve steady dividend growth going forward.

HP utilized $582 million of cash during the third quarter to repurchase shares of common stock in the open market. HP exited the quarter with $14.8 billion in gross cash.

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Source: Q3 2014 Results presentation

Competitors

A comparison of key fundamental data between Hewlett-Packard and its main competitors is shown in the table below.

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Hewlett-Packard has the lowest Enterprise Value/EBITDA ratio and the lowest price-to-free-cash-flow ratio among the stocks in the group. However, its PEG ratio is the highest.

Ranking

According to Portfolio123's "All-Stars: Piotroski" powerful ranking system, HPQ's stock is ranked second among all S&P 500 tech stocks, only Xerox (NYSE:XRX) is ranked higher (see my article about XRX). The "All-Stars: Piotroski" ranking system is based on investing principles of the well-known investor, Joseph Piotroski. The ranking system is quite complex, and it takes into account many factors like; price-to-book value, gross margin, debt, current ratio, return on assets, and share buybacks, as shown in the Portfolio123's chart below.

Back-testing over fifteen years has proved that this ranking system is very useful.

Technical Analysis

The charts below give some technical analysis information.

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Chart: finviz.com

The HPQ stock price is 4.44% above its 20-day simple moving average, 6.52% above its 50-day simple moving average and 19.56% above its 200-day simple moving average. That indicates a short-term, mid-term and a long-term strong uptrend.

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Chart: TradeStation Group, Inc.

The weekly MACD histogram, a particularly valuable indicator by technicians, is at 0.00, which is a neutral signal (a rising MACD histogram that is crossing the zero line from below is considered an extremely bullish signal). The RSI oscillator is at 74.90 which indicate overbought conditions.

Analyst Opinion

Analysts' opinion is divided, among the thirty-four analysts covering the stock, seven rate it as Strong Buy, six rate it as a Buy, twenty rate it as a Hold, and one analyst rates it as an Underperform.

TipRanks is a website that ranks experts (analysts and bloggers) according to their performance. According to TipRanks, among the analysts covering HPQ stock there are sixteen analysts who have the four or five star rating, eleven of them recommend the stock, and five top analysts rate it as a Hold.

On August 21, Citigroup's analyst Jim Suva maintained a Buy rating and $40 target, but trimmed his 2014 estimates slightly. Mr. Suva said that management is slowly regaining investor confidence by meeting or beating Street expectations in each of the past three quarters.

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Source: TipRanks

Major Developments

In May 2012, Hewlett-Packard adopted a multi-year restructuring plan designed to simplify business processes, accelerate innovation, lower costs and deliver better results. HP previously estimated that 34,000 positions would be eliminated in connection with the plan. As HP continues to reengineer the workforce to be more competitive and meet its objectives, the previously estimated number of eliminated positions will increase by between 11,000 to 16,000. HP is well along in the process of scaling its business units for the challenges ahead. The company modestly raised the low end of its FY14 EPS guidance range.

HP's turnaround has started to show encouraging results. The company reported third-quarter net revenue of $27.6 billion, up 1% from the prior-year period, its first year-over-year revenue gain in three years. Personal Systems revenue was up 12% year over year with a 4.0% operating margin. Commercial revenue increased 14%, and consumer revenue increased 8%. Total units were up 13% with desktops units up 9% and notebooks units up 18%. Last quarter was the third straight quarter that the Personal Systems segment achieved revenue and cash flow growth. Market reaction to the results was very positive, and HPQ's stock surged 5.35% the next trading day.

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Source: Q3 2014 Results presentation

In my opinion, HP will continue to benefit from the increasing demand for PCs as Personal Systems represent about 30% of HP's net revenue. That trend was also affirmed by industry research firm Gartner. In a press release from July 09, Gartner said that after eight quarters of declining shipments, worldwide PC shipments experienced flat growth in the second quarter of 2014. According to preliminary results by Gartner, worldwide PC shipments totaled 75.8 million units in the second quarter of 2014, 0.1% increase from the second quarter of 2013. According to Gartner, HP's market share in worldwide PC unit shipment estimates for 2Q14 was 17.7% up from 16.2% market share in 2Q13.

HPQ's stock started its strong rally in January 2013, and continued to perform very well in 2014. Since the start of the year, HPQ's stock has gained 31.7%, while the S&P 500 index has risen 7.6%, and the Nasdaq Composite Index has increased 8.7%. Moreover, since the beginning of 2013, HPQ's stock has recorded an astounding gain of 158.5%, while the S&P 500 index has increased 39.4% and the Nasdaq Composite Index has risen 50.3%. Nevertheless, considering its compelling valuation metrics, the stock, in my opinion, still has room to move up.

Conclusion

Hewlett-Packard will continue to benefit from the increasing demand for PCs and share gaining in this market. The company has compelling valuation metrics; its EV/EBITDA ratio is extremely low at 5.63. Hewlett-Packard is generating much cash; its ttm price to free cash flow of 10.34 is very low. Furthermore, HPQ's stock is ranked second among all S&P 500 tech stocks, according to Portfolio123's "All-Stars: Piotroski" powerful ranking system. The company continued to deliver large sums of cash back to shareholders; during the third quarter the company generated $3.6 billion in cash flow from operations, and returned $881 million to shareholders in the form of share repurchases and dividends. All these factors bring me to the conclusion that HPQ stock is a smart long-term investment.

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.