Hewlett-Packard Is an Attractive Value

Mar.14.11 | About: HP Inc. (HPQ)
Hewlett-Packard (NYSE:HPQ) is a leading global provider of products, technologies, software, solutions and services to individual consumers, small- and medium-sized businesses, and large enterprises, including customers in the government, health and education sectors. The company offers one of the IT industry's broadest portfolios of products and services. Its offerings span:
  • Multi-vendor customer services, including infrastructure technology and business process outsourcing, technology support and maintenance, application development and support services, and consulting and integration services;
  • Enterprise information technology infrastructure, including enterprise storage and server technology, networking products and solutions, information management software and software that optimizes business technology investments;
  • Personal computing and other access devices;
  • Imaging and printing-related products and services.
HP and its operations are organized into seven business segments for financial reporting purposes: Services, Enterprise Servers, Storage and Networking [ESSN], HP Software, Personal Systems Group [PSG], Imaging and Printing Group [IPG], HP Financial Services ["HPFS"], and Corporate Investments. Graph 1 gives an overview of the revenue per segment for the first quarter of fiscal year 2011.
Graph 1: Revenue per Segment
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In the last years, HP focused on increasing its operational efficiency. As part of those efforts, it will continue to execute on a multi-year program to consolidate real estate locations worldwide to fewer core sites in order to reduce IT spending and real estate costs. It also continues to implement the restructuring plan announced in the fourth quarter of fiscal 2008 to optimize the cost structure of the Services business.
In June 2010, it announced and started implementing a new restructuring plan that will consolidate data centers, systems and tools to better position the enterprise services business for growth.
HP is adapting quickly to take advantage of new trends in the fast-changing IT industry. It is investing for growth by strengthening the position in core markets and accelerating growth in adjacent markets in anticipation of market trends, such as data center consolidation and automation, cloud computing and virtualization, digitization, IT security, and mobility and connectivity.
HP has around $20 billion in debt, $10 billion in cash and generates around $10 billion in free cash flow a year. You can look at it as a debt-free company. The dividend hasn’t increased in the last years. HP is using its cash for acquisitions and an aggressive share buyback program. HP repurchased 51 million shares in Q1 of Fiscal year 2011. It has a remaining authorization to repurchase for $8.6 billion of shares. This is close to 10% of the total shares outstanding against the current market capitalization.
Gross margins have been between 23 and 26% and revenue has almost tripled from $45 to $126 billion in the last 10 years. The return on equity is currently around 20%. Graph 2 gives an overview of key financial figures and metrics.
Graph 2: Key financial trend and figures
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During the announcement of its Q1, 2011 results, HP lowered its 2011 revenue guidance to $130 - $131.5 billion, from a range of $132 - $133.5 billion and provided EPS guidance of $4.46 - $4.54. HP Stock is currently trading 24% below its 52 week high of $54.
We’ll use the Earnings Power Value method to come to an estimate of intrinsic value. First earnings need to be adjusted to represent the cash investors can extract and still leave the company functioning. Secondly, we need to determine a discount rate. Lastly, we’ll estimate the future growth of the company
Following adjustment to the earnings reported in its latest quarterly submission:
  • EBIT margin of 10%
  • SG&A, R&D and Depreciation adjustment
  • Tax rate of 20%
  • Discount rate of 12%
To estimate future growth we’ll take a conservative growth percentage of 6.5% (average revenue growth in the last 3 years), cost of capital of 9% and a ROIC of 14%. This gives an intrinsic value of $55 per share, a 25% discount versus the current stock price (~$41).
Let’s look forward and determine the intrinsic value following HP 2011 guidance. We’ll redo the calculation using the following assumptions:
  • Revenue of $130 Billion
  • Share buy-back to continue against the current rate
  • Maintain the EBIT margin, Tax Rate and Discount Rate
This gives an intrinsic value of around $68 per share, a 40% discount to the current stock price.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in HPQ over the next 72 hours.