I routinely use stock screens with various valuation criteria to come up with lists of stocks I can further research for potential addition to my portfolio. Of course, valuation isn't my only criterion -- I analyze dividends, analyst opinion, and earnings/cash flow growth, among other things.
Imagine my surprise when one of my screens turned up Hewlett Packard (HPQ) as one of the stocks analysts were currently bullish on. While I've heard good anecdotes about CEO Meg Whitman, the general investor consensus seems to be fairly negative on HP's near-term future. So I decided to do some digging to figure out why analysts might be bullish.
(Of 30 analysts covering the company, 5 have a "strong buy" recommendation, 4 have a "buy" recommendation, 16 have a "hold" recommendation, and 5 have a "reduce" recommendation. None have sell recommendations.)
HP: How Painful Is It Really?
Just looking at the stats, it seems that HP isn't really as bad as everyone makes it out to be. Trailing P/E is only 7.2, and forward P/E is a ridiculously low 4.8. Analysts have price targets ranging from $20 (essentially the current stock price) to $39, with a mean of $27.90 (upside of 40%). HP has beat earnings estimates five times in the past six quarters. The dividend yield is currently 2.7%, and while the balance sheet and income statement could be better, they aren't exactly falling apart. HP stock certainly looks like a good value just from the stats.
But as always, the stats don't tell the whole story. Take, for example, Meg Whitman's own statement at the HP Discover Conference on June 4th, 2012:
Usually these kinds of turnarounds take anywhere between four or five years. To have HP humming exactly the way I envision it -- this is a big undertaking.
To be sure, HP's plans are ambitious. First off is a rather large layoff/"strongly encouraged retirement" plan totaling 8% of the workforce, in which HP plans to trim 27,000 jobs by fiscal 2014 to save about $3 billion. As for the actual products that HP is looking to sell:
Looking further out in consumer devices, she said, "you'll see a lot of new form factors that no one has contemplated yet." [...]
Ms. Whitman's vision for Hewlett-Packard's corporate business, delivered Tuesday in Las Vegas, combines cloud computing, security and data analysis. Cloud computing "is a huge opportunity for us," she said, "as big as client-server."
On paper, HP's plan certainly sounds great. But their track record hasn't been so great, with profit and revenue flat at best over the past few years.
The key question, of course, is whether HP's measures will work. While Whitman envisions a Starbucks-like turnaround, HP has a poor history with mergers and acquisitions. The $13.9 billion acquisition of Electronic Data Systems in August 2008 nearly doubled HP's workforce, yet did little to improve revenues or profits. HP recently spent $11B to acquire Autonomy, a software company, in hopes of integrating this software across their product offerings. Will this acquisition work better than the previous ones? Only time can tell.
I certainly believe in Meg Whitman's potential, and in the future, the HP turnaround might be viewed as favorably as the Xerox turnaround. However, HP is facing a tough road ahead. By the time they get their business streamlined, competitors like Dell may already have the lion's share of data-center business.
HP's main problem, according to several sources, is that they slashed spending in the wrong places. A shredded R&D budget doomed the company's efforts to create a tablet and various other products, and that lack of innovation is what has effectively crippled the company's profits:
"We didn't make the investments we should have during the past few years to stay ahead of customer expectations and market trends," Whitman said. "As a result, we see eroding revenue and profits today. We need to invest now as a market leader from a position of strength, and that's especially true because these businesses are not only under intense competitive pressure but are also under pressure from tectonic shifts that are taking place at the very foundation of the industry."
Conclusion
It's clear enough to me that Meg Whitman deserves the confidence of HP's Board -- her plan seems sound. She's identified the problems facing HP and is coming up with solutions.
Whether HP deserves investor confidence is another matter entirely. Just based on HP's ridiculously low valuation, I might buy a few hundred shares and sit on them for a decade to see what they do for me. At a forward P/E of 4 point something, I have a hard time seeing how the shares have all that much more downside -- especially since HP is engaging in multiple cost-cutting and revenue-increasing measures that should boost EPS. However, until I see more direction on HP's cost-cutting measures and proof that HP can remain competitive and innovative in the changing market, I would not hold HP as one of my "core technology" positions as I would Seagate and Intel. Thus, my view on HP's turnaround is best summed up as "cautiously optimistic."
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in HPQ over the next 72 hours.
Additional disclosure: I am long Intel Corporation (INTC) and Seagate Technology (STX).
