Negative Sentiment Yields a Strong Value Play
Ryan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Wall Street has the tendency of overreacting to bad news and beating down a company far more than is justified. That is currently what is happening to Hewlett Packard (NYSE: HPQ). Sure, HP has made some mistakes, most notably its growth through acquisition strategy, which has presumably ended with the Autonomy blame game.
But Hewlett Packard is an iconic brand with diversified revenue streams. The world’s largest technology company, HP brings together a portfolio that spans personal computing, printing, software, services and IT infrastructure to solve customer problems. HP isn't going to become irrelevant overnight.
A flurry of bad news has pushed HP shares well beyond fair value. Hewlett Packard’s most recently reported non-GAAP earnings per share of $1.14 were overshadowed by news of an $8.8 billion impairment charge. In addition to failed acquisitions, other factors such as weakness in PCs and printers, the perception that the turnaround is not materializing quickly enough, the belief that HP is too far behind competitors like IBM and Apple (NASDAQ: AAPL), and the assumption that HP is too dependent on companies like Intel and Microsoft for innovation and sales, have turned doubters into cynics, have made bad news worse, and have caused HP’s share price to tank. It does, however, appear that HP bottomed out at $11.35 and has since stabilized.
What Is the Plan?
According to the CEO, Meg Whitman, the focus is on fixing the balance sheet. FY13 is a ‘fix and rebuild year,’ FY14 is a ‘recovery year,’ and early signs of a turnaround will appear in FY15 while full recovery may not occur until FY16. HP will slash 29,000 jobs, invest more in R&D and accelerate product development, leverage its scale, and give its customers what they want. The most recent forecast for FY13 is $3.40 – $3.60 per diluted share in non-GAAP earnings. The cost-cutting plan should keep net income flat or better over the next few years.
What Is a Fair Valuation?
The average earnings multiple of S&P is currently around 15 whereas HP’s current forward multiple is around 4. That compares favorably with competitors such as Oracle (NASDAQ: ORCL), Apple and DELL (NASDAQ: DELL).
Oracle is trading at a P/E ratio of slightly more than 15. Although HP and Oracle compete in the same space, over the past 10 years Oracle has grown both earnings and revenues every single year. In contrast, HP has cut jobs and is stabilizing operations. In addition, analysts have bought into Oracle’s growth strategy (whereas we don’t see nearly as many believers in HP’s). Plus investors also like Oracle’s high margins, which approach 30%.
Apple is trading at a P/E ratio of around 12. That reflects Apple’s dominant leadership position and strong brand equity. But it also reflects Apple’s already extremely large market cap of around $480 billion, margin erosion, and negative earnings growth over the past 3 quarters.
Dell is trading at a P/E ratio of around 7. Of the three companies, Dell is the company that is the most similar to HP – in terms of operations, financial metrics, and outlook. And both Dell and HP are in the midst of turnarounds.
A reasonable multiple of 7 would suggest a valuation of $3.50 (earnings estimate) x 7 = $24.50. That points to unreasonable negative assumptions, mispricing and a healthy upside.
3 Reasons to Buy Hewlett Packard
Hewlett Packard is attractively valued. Price matters. Would you rather buy 10 shares of Apple at $500 per share or over 400 shares of HP at slightly less than $13? Although Apple is a great company, I will make the latter bet. HP is in the same place that Bank of America and General Electric were in not so long ago. A few years ago General Electric, a diversified company, was unfairly lumped in with all of the banks, and its share price plunged to below $9 a share. More recently, this year Bank of America, which was the worst performer last year, is the best performer among the 30 stocks of the Dow Jones, increasing by approximately 100%.
Hewlett Packard is a much more stable company than people are giving it credit. From 2008 to 2011, for example, HP consistently reported EPS of over $3 per share. Likewise, improvements in one area of the business tend to more or less offset declines in other areas such as the PC business, which contributes just 15% of HP’s pretax operating profit. A dividend of around 3 – 4%, which is about double the average of the S&P, further underscores HP’s stability.
- Hewlett Packard is investing more heavily in R&D and product development. HP is positioning itself to capitalize on the booming cloud computing market. HP is also releasing new printers, producing better products like the hybrid tablet-laptop, focusing on extracting value from big data and analytics, and ensuring that it both understands and meets its customers’ needs.
My Foolish Take
On one hand, naysayers argue that the company is far too large and complex for someone to competently manage, that the turnaround is not happening fast enough, that HP needs to show that it can compete with Apple and IBM and Oracle and many of the other tech players, that HP has held on to an old product portfolio for too long, and even that HP is the next Kodak.
On the other hand, advocates argue that all of this is exaggerated, particularly the “death of the PC” and turnaround. Although there is a lot of finger pointing and making it look like Meg inherited someone else’s problems, in the end these temporary setbacks will all serve to magnify the accomplishment of turning around the world’s largest technology company. That being said, I feel that it is more likely than not that over the next 2 years HP shareholders will see HP rebound and cross the $20 barrier, providing a 30-50% return over that period. That is not unrealistic given that a few years ago when HP shares were trading in the teens, former CEO Mark Hurd initiated a turnaround that resulted in the stock price tripling over just a few years.
RyanPeckyno has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple and Oracle. Motley Fool newsletter services recommend Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!