By Jack Hough
(FROM BARRON'S 4/7/14)
Aging tech giants are suddenly enjoying youthful stock gains. Microsoft is
up 39% over the past year; Xerox, 33%; and Western Digital, 78%. That compares
with a 21% gain for the Standard & Poor's 500.
Hewlett-Packard (ticker: HPQ) stands out, not just for its 46% rise over
the past year, but for its valuation, which remains humble. At 8.7 times
projected earnings for the next four quarters, it trades at a 44% discount to
the market. By comparison, Xerox (XRX), at close to 10 times earnings, could
almost be mistaken for a glamour stock.
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There's much to like about HP's recent results: Costs are down, debt has
been slashed, and free cash flow is plentiful. There's also much to worry about:
Personal computers and printers are in long-term decline; competition in servers
is fierce; and overall revenue is slipping, albeit at a slowing pace. On the
whole, HP seems poised for further improvement -- and could even return to
revenue growth in coming quarters. Shares, recently $32.64, are priced for 20%
more upside over the next year. They pay a 1.8% dividend yield.
As recently as 2010, HP was the world's largest tech company by revenue.
But its shares, despite their recent run, go for the same price they did 15
years ago. Blame two factors. First, the Internet, which once made pricey PCs
and printers must-have items, has evolved to a centralized power structure. Now,
the heavy-duty processing and storage is done in faraway data centers, so
today's user can get by with a cheap tablet or notebook. Smartphones, meanwhile,
have helped reduce the need to print and carry pages. Second, HP made two big,
wasteful acquisitions: a $25 billion deal in 2001 for computer maker Compaq,
which ultimately netted HP little more than a Q in its ticker symbol, and an
$11 billion purchase of software maker Autonomy in 2011, followed by a
near-total write-down a year later after the discovery of dodgy accounting.
Vladimir Putin may have gotten a better return on the $51 billion he spent to
showcase Russian hospitality at the Winter Olympics before invading Crimea a
week later.
Former eBay chief Meg Whitman took the top spot at HP in 2011, a year
after coming up short in a bid for California governor. Layoffs were inevitable.
Since rolling out a May 2012 restructuring plan, HP has announced 34,000 job
cuts, shrinking its workforce by 11%. By carefully managing inventory and
keeping capital spending in check, the company has generated an impressive
amount of free cash -- more than $15 billion in its past two fiscal years,
equal to about a quarter of the company's stock market value. Long-term debt is
$18 billion, down from nearly $23 billion at the end of fiscal 2011, and
cash has doubled to more than $16 billion. Effectively, HP is debt-free, after
adjusting for its cash and the portion of its debt used to fund routine customer
financing.
Some analysts detect improving customer experience and rebounding employee
confidence. "It's nothing groundbreaking, just basic blocking and tackling,"
says Barclays Capital analyst Ben Reitzes, who raised his rating on the stock to
Overweight from Neutral last month.
"We've reignited innovation while at the same time aligning our cost
base," Whitman told Barron's in an e-mail exchange. "And we've rebuilt our
partner and channel relationships. But there is still more to do." Among the
behind-the- scenes changes Whitman lists, HP has upgraded the software its
salespeople use and reduced the number of HP contacts for each customer and
partner.
Revenue at HP is expected to decline for a third straight year, by 1%, to
$ 111.2 billion, in its fiscal year ending October. Despite a rising stock
market and strengthening economy, spending on information technology remains
weak. That's partly because software specialists like VMware (VMW), owned by EMC
(EMC), have created programs that squeeze extra performance out of existing
storage and networking hardware. The legacy tech bigs, faced with lean
conditions in core markets, are trying to snatch one another's lunch. Networking
leader Cisco Systems has quickly taken share in servers. Oracle (ORCL), a
software specialist, is making gains with its Exa hardware.
In its fiscal first quarter ended on Jan. 31, HP reported revenue declines
in printing, software, and enterprise services, offset by slight gains in
personal systems and enterprise hardware. Overall revenue dipped 1%, to $28.15
billion -- but that was nearly $1 billion more than Wall Street expected.
Excluding restructuring and other charges, earnings per share rose 10%, to 90
cents, topping estimates by a nickel.
The results left some analysts pondering a return to year-over-year
revenue growth, which could lure more investors to the stock. JPMorgan Chase
analyst Mark Moskowitz points out that overall growth could resume as drops in
service revenue slow.
HP could also benefit from a pickup in broad information-technology
spending. This past week, Gartner, a tech research group, said IT buyers
worldwide are on track to spend 3.2% more this year. With or without that tail
wind, HP has a near-term shot at taking market share. International Business
Machines (IBM) announced in January that it will sell its low-end server
business to Lenovo Group (0992.Hong Kong). After IBM's sale of its ThinkPad
notebook business to Lenovo in 2005, HP gained about a point of market share. If
it can repeat the gain in servers, the extra point of share will be worth about
$400 million in revenue, according to Barclays' Reitzes.
As for PCs, steep declines in recent years have at least set up easy
comparisons. Last quarter, HP reported an 8% rise in commercial PC revenue to
offset a 3% drop in consumer PCs. Microsoft (MSFT) could give commercial PCs
some support -- by cutting support for enterprise customers still using Windows
XP. Some holdouts who finally get around to upgrading their operating systems
will likely splurge on new machines, too.
None of this points to fast revenue growth anytime soon, but even slow
growth is more than the stock needs, says Larry Pitkowsky, co-manager of the
GoodHaven fund, in which HP is the top holding. "We're cautiously optimistic,"
he says of HP. "Meg has right-sized the organization for where revenues are, and
has very quickly brought stability and focus."
HP says half of free cash flow from here will go toward dividends and
share repurchases. Acquisitions are also a possibility. They will likely add to
HP's pockets of growth -- cloud computing, security, and data analysis -- and
will be considered "through a returns-based lens," says Whitman.
A 20% gain from here over the next year would put HP shares at close to
$40, with a Xerox-like valuation of about 10 times earnings, based on next
year's forecast. That seems a low hurdle.
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