Hewlett-Packard Company (HPQ) operates in the Diversified Computer Systems industry. Hewlett-Packard Company and its subsidiaries provide products, technologies, software, solutions, and services to individual consumers and small- and medium-sized businesses, as well as to the government, health, and education sectors worldwide.
I think this stock is undervalued by up to 79% or even more. Below are my calculations using FCFF model, multiples comparison and other interesting facts and threats.
Discounted Free Cash Flow Valuation
In this article I will run you through my DCF model. In particular I will be using free cash flow to the firm FCFF model to evaluate the stock. Feel free to share your opinion regarding the assumptions I made for this valuation.
Let's start with the top line. The company recorded $127.24B revenue in 2011, which represented 1.24% growth Year/Year. In 2010 revenue grew by 9.72% compared with 2009. In 2012, however, I predict that the company will record lower $122.41B revenue, and modest 1.77% recovery in 2013. I predict 2% growth for the next 2 years and no growth for 2 years afterwards.
Coming down to the cost side I predict COGS 74%, SG&A 13% and EBIT margin 7.5-8.5% of revenues for the projected period. Interest expense should stay at around 3% of the long-term debt. I forecast taxes to be 22% on average for the projected period.
Then I subtract increases in working capital and capital expenditures. I model working capital to increase 10% of the revenue increase per annum. Capital expenditures should stay at 64% of the net income.
This model uses WACC to discount FCFF backwards to find out the present value. Beta of this stock is 1.08. I project the WACC to be 6.99%. However, I believe in reality WACC could be higher on average in the long term so I will do further calculations with 10% WACC.
To get the value of the firm we need to discount the projected FCFF by WACC and add the terminal value at the end of the 5-year period by calculating a perpetuity with contraction of 2% and 10% WACC.
I get the value of equity by subtracting the market value of debt and adding back current cash and marketable securities.
Equity value per share is $39.50, which means the stock is 79% undervalued.
Multiples Valuation
HPQ is also undervalued in terms of P/E (7.72) compared with the industry (19.70). It is also undervalued to the biggest direct competitors: International Business Machines Corporation (IBM) has P/E of 14.76, Accenture plc (ACN) - 15.48 and Dell Inc. (DELL) - 7.95.
In terms of P/S, HPQ has lower (0.35) ratio than the industry average (1.28) and lower than mentioned competitors: IBM - 2.13, ACN - 1.38, DELL - 0.42.
Analyst ratings
The median analyst target price for GD is $28.5, which shows more than 29% upside potential.
More positive facts
- I projected the long-term growth of the company quite conservatively. Some brokers are forecasting up to 3.5% long-term growth, which of course would mean ever more upside for the stock.
- The company also has 2.2% annual dividend yield and a good history of paying dividends.
- The company also has a strong stock buyback history over the last 10 years.
- Satisfactory pricing power with stable gross profit margin of 23-24%.
- Consistent and significant cash flow growth during the last 10-year period.
- Satisfactory and consistent return on equity at 14.64%.
Threats
- HP net profit margin is consistent, but quite low at approximately 5-7%, which shows highly competitive industry.
- High capital expenditure ratio of 55% on average.
- The cash position in the company has weakened during the last couple of years.
Hewlett-Packard is scheduled to report its Q2 earnings results after market closes on May 23, 2012.
Financial data taken from Yahoo Finance.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
