By Siraj Sarwar
Hewlett-Packard (HPQ) and its subsidiaries supply products, technologies, solutions, software, and services to individual customers and both small and medium-size businesses. HP also provides products, technology, services and software to the government, health, and education industries globally.
The stock was among the biggest losers of the week. It lost almost 10% in a single day, after it announced a disappointing FY13 EPS guidance of $3.4 - $3.6, which is well below analyst estimates. Nevertheless, I think the market has overreacted to the bad news, and the stock is deeply undervalued. At the current price, an EPS of around $3.5 suggests a forward P/E of only 4.5. That is a remarkably low number for a technology company such as Hewlett-Packard.
For Q3 of 2012, the company produced a GAAP loss of $5.49 per share. The loss of $5.49 per share was primarily caused by the impairment of goodwill and amortization, as well as the impairment of intangible assets. Meanwhile, the Personal Systems Group delivered revenues of $8.6 billion, down ten percent year-over-year. Service revenues also fall down by three percent year-over-year. Furthermore, Enterprise Servers and Storage and Networking (ESSN) revenues both dropped by four percent. Software revenue, however, increased by 18 percent, . HP Financial Services sales were flat.
Three months ended July 31
Earnings (Loss) from Operations
Personal Systems Group (In Millions)
Imaging and Printing Group
Enterprise Servers, Storage and Networking
HP Financial Services
(Table is sourced from Company website)
Hewlett-Packard is operating in seven segments. While analyzing HP, most analysts choose to focus on the reduction of the company's Personal System Group because Hewlett-Packard is one of the global leaders in the PC market. However, it is my assertion that this approach is incorrect and, in fact, there are three other business sectors that yield higher earnings than the PC sector. In addition, the PC sector has the lowest operating margin in a group of seven total segments.
The Service segment is on top. This segment contributed to 37 percent of HP's total earnings last year and 30 percent of total earnings in Q3 2012. The segment has an operating margin of 11 percent. The Imaging and Printing segment produced 28.5 percent of the total earnings, and 20 percent in the latest quarter. This segment has an operating margin of 15.8 percent. The Enterprise segment was third, as it produced 21.7 percent of earnings. Thus, the PC group is in the fourth place in order of significance to Hewlett-Packard.
The PC business is not of particular importance to HP. Therefore, in this particular field, Dell (DELL) or Lenovo could prove better investments in the short-term. While the PC group was HP's largest business segment, as judged by Q2 revenues, it was fourth in terms of EBIT. Moreover, the PC business comprises only 17 percent of HP's total profits. It is a well-known fact in the industry that PCs are a weak business area. Thus, it is a fair assumption that the PC business will deliver an even smaller percentage of HP's total value.
Capital Allocation and the Balance sheet
This tech company is committed to rebuilding its balance sheet. Operating cash flow was up quarter-on-quarter to $2.8 billion, and free cash flow was recorded at $2.1 billion. Total gross cash at the end of the quarter was $9.9 billion. During the period in question, Hewlett-Packard returned $365 million in cash to shareholders through share repurchases. The company now has $9.3 billion remaining in its authorized share repurchase program. HP has also increased its dividends by ten percent, paying $260 million to shareholders in the form of nifty dividends.
5 year Rev CAGR%
(Graph is sourced from Morningstar.com)
Hewlett Packard's chief industry competitors are International Business Machines Corp (IBM), Dell, and Lenovo Group (LNVGY.PK). Hewlett Packard has a market capitalization of $34.58 billion. Meanwhile, IBM, Dell and Lenovo Group have market capitalizations of $235.39 billion, $17.98 billion and $8.3 billion, respectively.
At present, HP has a high dividend yield of 2.9 percent. On March 26 of this year, it increased its dividend yield by ten percent, from $0.12 to $0.132. HP's quarterly dividend per share has increased 65 percent since April 2011.Meanwhile, IBM and Lenovo Group have dividend yields of 1.6 percent and 1.2 percent, respectively.
In comparison with its competitors, HP has a satisfactory D/E ratio. HP's D/E ratio currently stands at 0.8, while IBM's D/E ratio is 1.2 and Lenovo Group has a D/E ratio of 0.8. HP, however, has lower P/E ratio among its peers. IBM, Lenovo Group and Dell support P/E ratios of 12.2, 235.2, and 4.8, respectively.
HP is making considerable progress in spite of various roadblocks. The company has taken vital steps in order to improve its focus on certain strategic goals. HP is mainly focused on managing costs, organizational changes, and strengthening its balance sheet. In my opinion, HP must also focus on increasing sales but, encouragingly, they seem to be doing just that. HP is taking many positive steps toward increasing its sales in all seven of its sectors. The company is currently generating solid cash flows, which will ultimately be delivered to the pockets of shareholders.
I am also encouraged by the promise made by HP management to refrain from large purchases in the future. Meg Whitman declared early on in her time at HP that the corporation would cease big acquisitions. The company will instead concentrate on organic R&D investments. So far, I do not see any reason to question Whitman's assertion. I believe that, over the next couple years, patient investors will be generously rewarded.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.