Will HP Continue To Dwindle?

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The negative market sentiment towards Hewlett-Packard (NYSE: HPQ) hasn’t subsided, and the company’s fourth quarter financial reports didn’t offer much comfort. According to the recent fourth quarter financial reports, HP’s revenues and earnings tumbled down again.

HP had an $8.8 billion provision due to “serious accounting improprieties, disclosure failures and outright misrepresentations at Autonomy Corporation plc that occurred prior to HP's acquisition of Autonomy.” The  sharp increase in the company’s credit default swap in the past couple of years suggests that the market believes there is a much higher probability of the company defaulting on its debt today than in the past. Is the company doing as bad as many believe? Let’s examine the recent developments in the company’s financial situation.  

HP CDS on the rise

The price of the company’s credit default swap has hiked in recent years: It has increased from nearly $30 back at the beginning of 2010 to nearly $330 as of last week. This represents an increase of 1100%. The current price of $330 means the annual premium is $330 thousand in case of a default of $10 million of debt within the next five years. As I have said earlier, this premium was only $30 thousand back at the beginning of 2010.

The chart below shows the developments of the 5 year CDS price in the past few years (weekly prices).

<img src="/media/images/user_12845/hp-credit-default-swap-price_large.jpg" />

One of the reasons for the sharp rise in the CDS price is the ongoing fall in the company’s stock price. During the year, shares of the company have tumbled down by nearly 48%. The sharp drop is plausibly due to the company’s drop in sales, rise in debt, and fall in profitability. Let’s further dwell on these issues.     

Financial Reports Continue to Show Contraction

The recent fourth quarter financial reports of HP were, again, not positive. According to the company’s quarterly reports, its quarterly revenues declined by 7% from the parallel quarter in 2011. Moreover, the company’s operating profitability tumbled into the negative, mainly due to the company’s provision of nearly $8.8 billion for “Impairment of goodwill and purchased intangible assets” and another $380 million for restructuring changes.

The $8.8 billion provision is related to the company’s adjustment to the value of its holding in Autonomy Corporation plc. These adjustments didn’t affect the company’s cash flow but did reduce the value of its assets. When controlling for these one-time provisions (even though in recent quarters they have occurred more often), the company’s operating profitability in the third quarter reaches 9.1% compared to 6.1% in the fourth quarter of 2011. Therefore, after controlling for these asset price changes, the company’s profitability is slightly higher than in previous quarters. 

<img src="/media/images/user_12845/hewlett-packard-operating-profit-2011-2012_large.jpg" />

The main problem is that it’s hard to see how the company will turn its situation around and manufacture growth. The company’s R&D expense in the fourth quarter reached $909 million compared to $829 million in the same quarter in 2011. This modest growth in this provision suggests the company isn't allocating more funds to come up with new products. The collaboration between Microsoft and HP to integrate Windows 8 into HP’s tablet and ultrabook hasn’t yet yielded a positive response. Moreover, there are some reports that aren’t too positive about the Windows 8 interface.   

Another factor that may have also adversely affected the company’s stock is the rise in the company’s debt ratio. HP’s debt ratio (total liabilities/total assets) increased from 70% in the fourth quarter of 2011 to 79% in the recent quarter. This figure, however, isn’t much higher than other related computer companies’ debt ratio (the table only shows up to the third quarter). Further, HP’s debt ratio is in the middle of the pack as seen in the table below.

<img src="/media/images/user_12845/hewlett-packard-dell-apple-and-lenovo-debt-ratio_large.jpg" />

HP and S&P500

The company hasn’t performed well during the month and its stock fell by nearly 4%. Moreover, the S&P500 index also declined during that time by nearly 1.8%. Part of the drop in HP’s stock could be related to the recent fall in the stock market. During the month the linear correlation between changes in the stock of HP and S&P500 index reached nearly 0.7. This means, under certain assumptions, that nearly 48% of HP’s volatility could be related to the changes in the S&P500 index.

HP and Dividend

Perhaps the only sliver lining HP has is its relativity high dividend yield, which could further rise as the company’s stock continues to dwindle. As of last quarter, HP is offering a $0.13 quarterly dividend, which is a 3.97% yearly divided yield. In comparison, Dell (NASDAQ: DELL) is paying a $0.08 quarterly dividend, which is a 3.5% yearly divided yield; Apple (NASDAQ: AAPL) is offering a $2.65 quarterly dividend, which is a 1.87% yearly yield;  Lenovo (NASDAQOTH: LNVGY) is offering a $0.12 quarterly dividend, which is a 2.1% yearly yield.

It’s hard to find some positive news regarding HP. The recent quarterly reports didn’t offer any comfort and could continue to pull down the company’s stock and raise its CDS price. It's worth noticing that the company offers a relatively high dividend, its adjusted operating profitability has slightly increased, and HP'sdebt ratio isn’t much higher than other computer companies’ (excluding of course Apple). Despite these factors, it’s hard to see how the company will be able to produce growth in sales in future quarters and without growth this company’s stock is likely to suffer.


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Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.

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