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  • Hewlett Packard – Are The Rumors Of Their Demise Exaggerated?

    When a Nobel Prize-winning economist (Robert Shiller) says he's "worried about the boom in the U.S. stock market" (in this December 2013 Reuters story), then speculation about a market bubble has reached the mainstream. The next step usually comes when most media commentators throw in the towel and admit to some new paradigm or other reason that the market is going to move higher. The IT sector is experiencing particularly heady valuations, so is there a value play left? We look at Hewlett Packard.

    Nowhere is the euphoria more evident than in IT, where commentators are experiencing disconcerting tech-bubble déjà vu. However, some companies haven't arrived at the valuation party. One such large cap is Hewlett Packard (HPQ.N) which has yet to recover fully from the disastrous acquisition of Autonomy Corp. and the resulting $8.8 billion writedown. In many ways HPQ looks similar to Dell - it's only a shadow of its former glories.

    Maybe not a value trap

    The naysayers will scream that HPQ could be a black hole masquerading as a value proposition. And yet … StarMine's Analyst Revisions Model score is an impressive 84 (data from Jan. 3). This indicates that sellside sentiment is changing in a more positive direction, with longer term revenue and EPS estimates starting to drift higher (FY2 EPS estimates are up 4.6% over 90 days). It's a positive sign that EPS and revenue are moving in the same direction. According to StarMine, EPS revisions that are driven by revenue growth are normally more powerful than EPS growth that is not matched at the revenue or EBITDA line (i.e. probably driven by cost cutting).

    Price momentum also looks reasonable - the stock has a Price Mo score of 70 and has strong medium and long term momentum, as well as short term industry momentum (U.S. computers & peripherals are up by 5.3% over 30 days). So if this is a value trap, it's well-hidden. It appears to be more a stock starting to turn the corner with the market and sellside analysts starting to get on board.

    What about valuation? Well, HPQ trades at 7.7 times 2014 earnings - its 10 year median valuation is 11.3 times and its peers are trading at an average of 11.6. Looking at its valuation from another angle - the current price around $28.00 implies negative growth of 0.3% over the next decade. That certainly leaves some room for outperformance. StarMine's SmartGrowth forecasts, which take sellside short and long term earnings forecasts and attempt to remove over-optimism bias - still project a 10 year CAGR of 4.6%. Hardly bullish, and about half the industry average of 8.8%, but still enough to calculate a valuation of over $44.

    (click to enlarge)

    Earnings quality - check, cash flow - check

    Earnings Quality also looks robust, with operating efficiency continuing to move in the right direction and gaining a percentile score of 94. Free cash flow generation is also attractive, scoring in the 90th percentile for U.S. stocks.

    The hedge funds have also closed their shorts. The Short Interest model moved down to a score of 30 during the dramatic share price fall in 2012 but the shorts have drifted away - no doubt more attracted to the euphoric valuations of social media and cloud based analytics.

    Lastly, the sellside have not yet bought into the story - while recommendations are drifting higher, the average is still only slightly better than a hold. There are 23 holds and three sells - that leaves plenty of room for the unbelievers to convert and institutional interest to start to return.

    (click to enlarge)

    It's alive!

    HPQ has its challenges, no doubt, but with estimates drifting higher, an inexpensive valuation, and high levels of both buyside and sellside skepticism, it seems that HPQ doesn't need to do much to give the market a positive surprise. The tablet has certainly had a transformative effect on the industry - but the desktop PC, laptop and printer are not dead. Perhaps rumours of Hewlett Packard's demise are also exaggerated.

    Jan 10 4:48 PM | Link | Comment!
  • Can Manchester United Score A Goal In The Market?

    Investors subject themselves to the whims of fate whenever they put their cash to work in the capital markets. Buying shares in a football team (soccer to Americans) adds an extra element of unpredictability, although you can watch your investment suit up and compete on television. We look at whether England's iconic Manchester United (MANU.N) can score goals in the market as well as on the field.

    MANU has long been recognized as one of the world's leading sports franchises. Founded in 1878, it is listed by Forbes magazine as the most valuable sports franchise in the world, with a value of more than $3 billion. The club itself claims to have 659 million supporters worldwide. However, today's fans see their team sitting at eighth place in Britain's Barclays Premier League, with a new manager (coach to Americans) just getting his feet wet.

    It's been a particularly tough month for MANU, with the stock down 9.8%, compared to a 2% gain in the S&P 500. The recent dip means 12-month performance is also disappointing - the stock is up 8.9% versus 25.95% for the large cap index.

    (click to enlarge)

    Wins and losses

    Investors are wondering - to what degree will equity market returns correlate with wins on the field? MANU shareholders will hope that the markets are focused on the longer term and the immense off-field earnings potential of the franchise. If they remain focused on performance, things don't look so great - the team got off to a shaky start this year under new manager David Moyes. His predecessor, Sir Alex Ferguson, having managed the team since 1986, finally retired at the end of last year - leaving behind a legacy of consistent success that has few sporting equivalents.

    It appears the fan base extends to the sell side - five of seven analysts covering MANU currently have a buy on the stock, and the mean price target is approximately $19.20 (the figure in Eikon is £11.80), compared to a current valuation of $15.23.

    MANU is also a challenging stock to evaluate just due to the volatility in its EPS numbers. As the chart below shows, both net income and free cash flow have moved around significantly in the last five years.

    (click to enlarge)

    Not a value proposition

    Whether you want to look at EPS volatility, valuation, analyst revisions or a variety of other factors, the StarMine scores certainly aren't bullish. With a F12M P/E ratio of 37.6, the recent price decline still hasn't brought the stock back to an attractive P/E ratio - and the StarMine Val-Mo model score of 3 tells the broader story - a stock still looking expensive from a variety of valuation measures, with analyst estimates still trending down and moderately negative price momentum.

    (click to enlarge)

    Watch for analyst downgrades

    The last factor worth noting are 2015 estimates. Here the SmartEstimate remains 5.7% below the I/B/E/S consensus, as more recent estimates and more accurate analysts tend to have made more bearish calls. The negative Predicted Surprise indicates a strong likelihood of further analyst downgrades as the I/B/E/S number tends to follow the SmartEstimate.

    (click to enlarge)

    Patience may be key

    So there appear to be challenging times ahead for the company, as well as the team. However, it's worth remembering that on his departure Sir Alex asked the fan base to be patient while the new manager found his feet. Considering the team's current position on the ladder, these were wise words. If the temporary swoon in team performance becomes a habit, then investors will need patience of their own.

    Jan 10 4:48 PM | Link | Comment!
  • Avis Budget: Is It Time To Invest?

    In the current market it's easy to forget how harsh a credit crunch can be. Loans are again being made on terms that leave the lender little margin for error; a similar situation exists in equity markets. As long as momentum (meaning the Fed) continues to play along, things look rosy but if the markets do become risk averse, there are stocks that don't appear to be discounting that eventuality. We examine whether one of them is Avis Budget Group Inc. (CAR.O).

    In a bull market, one factor that rarely works is Earnings Quality. In fact, the reverse is true. Investors want to take on more leverage and gain exposure to stocks that generally have more violent swings than the index - high beta. Thus the conservative high cash flow businesses tend to get ignored when times are good. The key to outperformance, in the eyes of the fund manager, is often the leveraged play that will only outperform while the music keeps playing, or until the tide recedes - pick your own metaphor.

    With the market now alarmingly relaxed about the commencement of Fed tapering, it may be time to start identifying the firms that are only priced for the good times. One potential example is Avis Budget, where the share price has moved from under $11 to almost $37 in two years. How much of that is earnings-driven? Well, not enough - the P/E has expanded from 6x to 14x, well above the 2-, 5- and 10-year averages.

    Avis recently bought the car-sharing company Zip Car for $500 million, moving into the faster growing 'new economy' area of car rentals, yet also facing operational challenges in terms of integration and cultural differences.

    (click to enlarge)
    Source: Thomson Reuters Eikon / StarMine

    Watch the insiders

    From an Earnings Quality standpoint there are some challenges, with Avis Budget scoring in the bottom 11% for North America, driven primarily by its low cash flow score. Equally, the stock appears to be facing some headwinds in terms of the StarMine credit default scores and from a short interest standpoint.

    So Avis Budget appears to be well-liked in the marketplace, with strong price momentum and analyst revisions as well as a moderate valuation. However when you look at the ownership metrics, we can see insider positioning tends to be negative and, perhaps most interestingly, hedge funds and other short sellers are starting to position themselves for a decline.

    Source: Thomson Reuters Eikon / StarMine

    Silver linings? Or clouds?

    None of these metrics are, of themselves, conclusive, they simply indicate an interesting dichotomy in market views. The traditional quant measures of valuation and momentum remain positive - but dark clouds tend to be appearing. The company, carrying a large debt load, has unattractive free cash flow characteristics and the Smart Holdings data are also slightly negative. This model looks at the types of investment strategies that are de rigueur with investment professionals today, and assesses whether those strategies are likely to indicate an increase in institutional ownership or the reverse - and in this case it seems a decrease is slightly more likely.

    From a sellside perspective the stock remains admired - with five buys and two holds outweighing a solitary sell recommendation. In terms of valuation, the median price target is $35.50 versus a recent close at $36.98, which highlights the limited support remaining from that valuation perspective.

    To give you a sense of the importance of capex (the car fleet) in the Avis story, let's look at cash flow from operations versus net income. It's an attractive chart, with CFO exceeding net income in almost all recent quarters.

    (click to enlarge)
    Source: Thomson Reuters Eikon / StarMine

    Judging the trend

    Yet if we look at free cash flow - i.e. a measurement after accounting for capital expenditures - then the situation seems less rosy. While credit markets remain accommodating, firms can exceed their debt limits significantly. Just ask the U.S. government. Yet looking at the overall trend in free cash flow, it's important to remember the investment axiom: if a trend is unsustainable - it will stop.

    (click to enlarge)
    Source: Thomson Reuters Eikon / StarMine

    Timing issues

    Stock and equity markets can remain overly accomodating for years - Mr. Greenspan's prescient warning was delivered more than three years before the market truly reached its irrational zenith. So the timing of such concerns is always uncertain. When risk aversion does mount, it seems clear that it will be the stocks with strong, sustainable cash flow, able to meet the exogenous shocks at a corporate or economic level, that will possess the capacity for outperformance. And you can't rent a decent balance sheet.

    Receive stories like this to your inbox as they are published. Subscribehere and follow us @Alpha_Now on Twitter or check out the Thomson Reuters Eikon blog. If you are looking to access Thomson Reuters data or analytics, register for a free trial.

    Dec 16 11:26 AM | Link | Comment!
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