Hewlett-Packard's Turnaround Looks Real

 | Feb 28, 2014 | 10:00 AM EST
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While Hewlett-Packard's (HPQ) stock is up over 60% in the past year, it is still one of the cheapest stocks by 2014 price-to-earnings ratio (about 8.1x 2014 estimated earnings) in the S&P 500 Index. We expect the stock to continue to move higher throughout 2014. 

We would recommend holders stay with their position and we would add to the position on any pull back below $29. 

We were very pleased (and pleasantly surprised) by last week's earnings call. The earnings were better than expected and cash flow was above expectations. The company lifted the low end of their earnings range for the year, and they even started to show very early signs of progress on the revenue front. 

We believe Meg Whitman is doing a terrific job as CEO and is the right leader to drive a positive transformation of the company. Prior to her taking over, the previous CEO was an operating and financial disaster who left an unprecedented amount of turmoil at the board and top management levels. While management still has several key initiatives to execute, the Hewlett-Packard ship has been righted under Meg's leadership. 

We don't believe that it will be clear sailing ahead. We also don't believe that HPQ will be revitalized into a growth company since several of the key business units; including PC's and printing, which face structural growth issues.

We believe these negatives will be overwhelmed, however, by the company trading as the second cheapest stock by P/E in the S&P 500 (source: Bernstein Research), and moving in a far better direction while having a stellar balance sheet. As such, we look for the stock to move higher from here. 

The following are some of the highlights from the most recent quarter and outlook:

  • Revenues were above expectations at $28.2 billion vs. $27.3 billion for the consensus. The revenue gains were led by positive traction in both PC's (up 4%) and Servers (up 6%). Printers were down modestly at 2%, while services continued to disappoint. This was the first positive revenue quarter in over two years, and shows the top-line traction the company is beginning to regain as management revitalizes the franchise.
  • Margins, earnings and cash flow were above expectations as top line growth and cost-cutting measures kicked in. Operating margins came in at 8.5% vs. 8.2% for the expectations. Earnings clocked in at 90 cents a share vs. 84 cents for the consensus. Cash flow was a surprising $2.4 billion vs. $1.7 billion expected. These vital profitability measures are all strong and much better than expected.  
  • Lastly, management sounded confident with regards to the balance of the year and the outlook. Investors walked away from the call with a positive bias to the rest of the year and boosted the upper end of their earnings estimates by 5 cents to $3.60 to $3.75.

With the better-than-expected results from the most recent quarter, there is a strong likelihood that Hewlett-Packard should continue to surprise to the upside in the coming quarters and years as the multi-year turnaround gains traction. With the stock trading at 8x earnings, investors should continue to buy into any share price weakness.

Management still has many levers to pull on the revenue, expense and balance sheet lines to improve shareholder value. With the continued better news, one could easily see HPQ's shares revalue to 10 to 11x earnings, leading to healthy capital appreciation potential from current levels.



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