HP Inc. (NYSE:HPQ) feels like an old friend. I owned the pre-split HP for several years, riding it from the teens into the $30s as investor hysteria faded. I sold, though, because I had no romantic attachment to the business - the thesis was strictly based on the absurdly low multiple to free cash flow at the trough. And once that normalized to a level more appropriate for a no-growth or shrinking business, I took my capital and moved on.
With the stock having fallen significantly both pre and post-spin, and now trading at a single digit multiple to non-GAAP net earnings guidance of $1.64 at the midpoint, I've been taking another look.
We'll start with PCs, which comprise more of revenue but less of operating profit. As I discussed in my recent piece on Intel (NASDAQ:INTC), industry consensus now appears to be pretty firm on continued long-term declines. While HP is holding steady on share, I'm not as optimistic as some regarding the potential Windows 10 refresh, and the competitive environment also is fierce.
In the medium to longer term, it's also worth thinking about whether the strong improvements in battery life enabled by newer generations of chips will continue to extend the refresh cycle over time. Think about it - old laptops that had 2-3 hour battery life to start with left you with battery anxiety within a few years. Now that smaller, more power-efficient laptops can get double or triple that battery life, there may not be as much need for personal users to replace laptops as quickly. This article from Digital Trends demonstrates the rapid improvements in battery life over just the past few years - and indications are that Intel's Skylake chips will continue the trend of Haswell and Broadwell toward greater efficiency.
On printing, the price war with foreign manufacturers enabled by currency issues is a real problem. Hardware sales were down significantly in Q3, and while this isn't necessarily a near-term issue (given the thin margin), it does portend lower sales of high-margin supplies. Currency issues haven't magically reversed through this quarter and overseas markets continue to be weak, so it's not immediately clear what will ease the brutally competitive environment here.
While Managed Print Solutions is supposed to be a bright spot, as I discussed in my write-up of ARC Document Solutions (NYSE:ARC), that doesn't appear to be as great of a market as some investors surmised either. And ARC's year-end CEO letter only increased my questions about the long-term value proposition here. Notably, I think ARC actually has one of the stronger value propositions in MPS, since it's OEM-agnostic and can thus provide clients with the solutions that best fit their needs, mixing and matching brands - so the questionable outlook for them bodes poorly for large-OEM MPS efforts.
So Is It Worth It?
While HP worked out for me the first time, I'm not so eager to jump on board a second time, particularly without what I would consider to be the more interesting half of the old business (i.e. HP Enterprises (NYSE:HPE)).
On the cost side, it's also worth noting that a) it's not clear how much more juice HP can squeeze out of cost-cutting beyond 2016, and b) these gains will not necessarily be purely incremental. Other OEMs have shown a willingness to compete on price, and they're not just sitting by with bloated cost structures either.
Significant international exposure will continue to be a headwind - "constant currency" results don't do you much good when the fundamental competitiveness of your business is impacted by exchange rates (as discussed above).
Finally, from a quality of earnings perspective, it's worth noting that next year's guided EPS numbers will be propped up by decent repurchase activity - so I don't consider that to be "incremental" value creation.
Ultimately, while I think HP deserves a slightly higher multiple, I don't think "slightly higher" is enough to justify taking on the risks here. If the multiple got down below 5x, it would be something I'd have to consider more seriously - but I have a hard time assigning a multiple higher than 10x EPS to the business given that I'm expecting mid-single-digit revenue declines in both segments and potentially some operating margin compression over time. This multiple would provide decent upside from here, but not enough in context of the risks.
Printers simply aren't an area that look attractive to me right now. There's obviously not a long-term growth story, and unless the strong dollar goes back the other way, it will be tough sledding for HP. On the PC side, Lenovo (OTCPK:LNVGY) - which Stephen Simpson recently covered - seems like a more attractive long-term holding from a "quality" perspective.
Disclosure: I/we 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.
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