the Dow Jones Industrial Average was reformulated
, former technology leader
was quietly replaced. It was yet another tough blow for a firm
that is on track for its third straight year of sales declines.
CEO Meg Whitman, who was just celebrating her second full year at
the company's helm, could not have been pleased.
But Whitman is surely getting the last laugh. Because against
the odds, Hewlett-Packard has turned out to be one of the
top-performing tech stocks of 2013. Shares have doubled in value,
putting the S&P 500 Index's 25% gain to shame. More than $25
billion in market value has been added, and Whitman has less need
to worry about job security.
Yet a deeper look reveals a company that remains mired in a
deep slump, and a stock price that is now sharply overvalued. As
UBS' Steve Milunovich noted in a recent report, "The stock has
rebounded as fundamentals improved from very poor to mediocre,"
adding that "HP appears secularly challenged with too much
hardware and a paucity of software revenue."
Indeed, the only good news for Hewlett-Packard is that it
isn't performing as poorly as many had expected. For example,
sales in HP's fiscal fourth quarter (which ended October) slipped
just 3%, compared with expectations of a 7% decline. The upside
came from a large one-time sale of computers in India, which
analysts believe came with very low profit margins.
Indeed, if Whitman was being assessed by profit metrics,
investors would be much less impressed. Hewlett-Packard's
earnings before interest and taxes margins fell from 10.8% in
fiscal (October) to 8.5% in fiscal 2013. The only reason that
margins haven't fallen even further is that Hewlett-Packard has
laid off 25,000 employees over the past few years.
To her credit, Whitman has consistently said that her strategy
revolves around belt-tightening. Hewlett-Packard has throttled
back capital spending, which set the stage for a solid rebound in
free cash flow to rebound from $6.9 billion in fiscal 2012 to
$8.4 billion in fiscal 2013.
Whitman has led Hewlett-Packard to become one of
the 2013's top-performing tech stocks. Shares have
doubled in value, while adding more than $25 billion in
Yet there's no masking the fact that sales continue to fall.
Analysts expect fiscal first-quarter sales to fall 4% (to $27
billion), and sales for the full year are expected to drop around
3%. Equally important, Hewlett-Packard can't continue to starve
capital spending, which is expected to rebound by at least $500
million (to around $3 billion). A slump in the company's
cash conversion cycle
will also hurt free cash flow. That's why management recently
predicted that this metric will drop to around $6 billion to $6.5
billion in the current fiscal year.
To be sure, Hewlett-Packard would likely have been faring a
lot worse were it not for some of the tough steps taken by
Whitman. And they haven't been just about cost cutting. For
example, savvy marketing in the printer division has led
quarterly revenues to stabilize at around $6 billion -- at a time
when printing rivals are stills seeing sales declines. Not only
is Hewlett-Packard taking market share in printing, but profit
margins haven't been sacrificed in the process.
Also, Hewlett-Packard has again becoming a relevant player in
data storage, growing divisional sales in line with the broader
Yet Hewlett-Packard remains poorly positioned in many other
divisions. For example, the company's once-proud IT services
division is now facing contract run-offs. "This is one of HP's
largest profit pools that may be in the midst of an increasingly
severe secular decline," note analysts at Goldman Sachs. And
Hewlett-Packard's huge exposure to personal computers is a
millstone at a time when
spearhead a consumer push toward tablets and smartphones.
Hewlett-Packard generates skimpy margins in the PC division,
which explains why the whole company continues to post gross
margins of just 23% (where they've been for nearly a decade,
despite a huge amount of layoffs). As a point of reference,
Apple's gross margins are 37%,
gross margins stand at 48%, and
still enjoys gross margins above 70%.
In the context of ongoing top-line pressures and a lousy
margin profile, what should this stock be worth? Consider that
the enterprise value is now roughly 9 times forward free cash
flow, up from a multiple of 5.5 a year ago. Goldman Sachs, which
prefers to use a price-to-earnings (P/E) ratio, estimates shares
are worth just $17, or five times their projected calendar 2014
earnings per share estimate of $3.36. That represents 40%
downside from current levels.
Risks to Consider:
As an upside risk, consumers may migrate back toward PCs and
away from tablet computers. This segment currently carries very
low expectations from investors.
Action to Take -->
Give Whitman credit for stabilizing a sinking ship and showing
the fortitude to oversee a massive shrinkage in Hewlett-Packard's
overhead. But she has given investors few insights as to how
Hewlett-Packard can once again become an industry powerhouse. The
secular pressures faced by Hewlett-Packard have not gone away,
despite the impressive share price rebound. And that is likely to
come back into focus in 2014, after Hewlett-Packard became one of
the top-performing tech stocks of 2013.
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