Hewlett-Packard (HPQ) set a new 52-week low last week when it traded at $20.22. The stock is now trading even lower. For the 52-week period, the share price is down by 41.63%.
From a historical perspective, this is the lowest price since May of 2005. For the record, this was about a month after Mark Hurd took over as CEO. Mark Hurd resigned in 2010 after a company investigation discovered that he violated company's standards of business conduct. Leo Apotheker assumed the role after Hurd's resignation. He was ousted after less than a year as investors believe that he could not fix Hewlett-Packard's core problems.
Meg Whitman replaced Apotheker late last year. Her plan is to concentrate on server technology and mobile devices. Of course, investors were concerned with this CEO replacement. Some analysts believe that the solution is not a new CEO, but an overhaul of the company's core focus. Obviously, this translates to the underperformance of its stock price. It seems that the market is not convinced that its current turnaround plans will work.
Based on the Bloomberg interview, current CEO Meg Whitman sees a Hewlett-Packard's turnaround similar to Starbuck's (SBUX) efforts in 2008. Whitman admitted that Hewlett-Packard's turnaround plan will not be easy amid the increasing competition in mobile devices and cloud computing. She noted that it would take around 4 to 5 years to fully execute the turnaround plan.
Her plan appears plausible and sound. The plan is to eliminate 27,000 jobs, equivalent to about 8% of its workforce for the next couple of years. This will result in costs savings of $3 billion to $3.5 billion a year. The cost savings will be reinvested in growth areas like cloud computing and services. It also plans to beef up its research and development moving forward. Around 9,000 or roughly a third of the cuts will occur this year. Whitman further added that it needed to manage its inventory very well to improve its cash flows. Hewlett-Packard currently has an annual operating cash flow of $9.27 billion. The company is expected to grow its cash flows by 4% over the next 5 years.
If you look at the Starbucks turnaround, there are two focus areas that brought major success. First, Starbucks sought operational excellence from supply chain to back-end IT systems. It discontinued some of its unprofitable products lines and replaced them. It also focused on customer intimacy to capture its needs. It all comes back to the basics of business: filling the needs of its customers and operating efficiently. I believe that Meg Whitman understands this.
Focus on products more than anything else
I believe that the key to success for Hewlett-Packard is a strong focus on its products. One of its major growth drivers will be its ultrabooks and sleekbooks lines. It has recently introduced the expansion of its laptop lines. The new ultrabooks are thinner and lighter than their predecessors. It has also lowered its prices in order to compete with Apple's (AAPL) Macbook Air.
According to a first quarter 2011 laptop report, Hewlett-Packard shipped 40,000 more PC units than Apple. However, it is interesting to note that HPQ has taken the top spot on a narrow margin. The competition is intense and the need to have better products than competitors is now more important than ever. The catalyst to having a wide margin over its competitors will be cheaper and superior product lines. This will pose a serious threat to Macbooks. The Ultrabooks price range starts at $799, cheaper than Apple's Macbook, and Dell's (DELL) XPS13, which starts at $999.
Part of the turnaround plan is to refocus on the failing services segment. The HP Cloud will help the company grow faster while increasing margins. The HP Cloud has the capacity to accelerate its cloud offering and increase adoption of both private and public cloud computing. Hewlett-Packard secured key contracts recently. It announced that it will provide cloud computing services under the Army Private Cloud Contract. There is not much competition in this space, with the exception of IBM (IBM), which has the capability to tap into large enterprises. Over time, Hewlett-Packard could also snatch some clients from Amazon (AMZN) and Rackspace.
The stock is currently trading at 7 times earnings. Hewlett-Packard maintains a dividend yield of 2.59%. Over the last five years, the stock has traded between 5 times to 19 times earnings. I believe that a reasonable valuation for Hewlett-Packard will be at 14 times earnings, in line with average industry valuations.
IBM is valued at 14 times earnings. On the other hand, Apple trades at 20 times earnings while Dell trades at 6 times earnings. Analysts estimate Hewlett-Packard's 5-year growth rate will be 4% per year. At this growth rate, earnings per share could reach $4.76. At 7 times earnings, the stock would trade at $33 per share. This is at the low end of the valuation range. I believe Hewlett-Packard could reach $67 per share in the next 2 to 4 years on a successful turnaround. Meg Whitman said that the turnaround plan is 10% to 15% complete. I estimate investors will have to wait for 85% to 90% of the turnaround plan to be executed before the stock price will trade at post-turnaround valuations.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.