We Are Late to the Party, but Not Too Late

 | Jun 18, 2013 | 10:00 AM EDT  | Comments
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It might seem rather untimely to be recommending Hewlett-Packard (HPQ) now. The stock has been a stellar performer this year, and the job of Real Money contributors is to help you be ahead of the curve, not to be part of the "amen" chorus. So, while acknowledging that we missed the initial liftoff, we also believe that there is still considerably more opportunity ahead for Hewlett-Packard.

Part of the reason for this is that Hewlett-Packard's re-emergence has been quite recent. Up until two quarters ago, we were very concerned that Hewlett-Packard was broken, that there would be more bad news on the horizon, and that unless the company fixed its balance sheet there was real risk to the franchise. Many worried that key long-time customers and employees would flee this storied Silicon Valley enterprise. 

The intensity of the progress of the company has all come in this brief, but impressive interlude.So, yes, we have been late on this one, for sure, and yes, Hewlett-Packard is up about 75% this year. However, this is off of its 2012 end-of-year swan dive, so it still ranks as one of the cheapest stocks in the market and has lagged the market's gains over the past 52 weeks. Even with its 2013 run up, in terms of valuation Hewlett-Packard is the least expensive company out of the major Fortune 50 and Fortune 500 firms at 7x 2013 earnings estimate of $3.56. Earnings are projected to rise to $3.73 in 2014 making the shares even cheaper.

While we had been hoping for a better entry point, the stock has not co-operated. Newly appointed CEO Meg Whitman and her team have done a remarkable job in the past 12 months: refocusing product lines, exiting unprofitable customers and dramatically reducing company-wide expenses. By 2014, Hewlett-Packard will have reduced expenses by more than $3 billion annualized and cut 30,000 jobs.

Nevertheless, we still believe there is a lot more upside from the current $25 share price. We have a target in the low-to-mid $30's level. Earnings should begin to rise as revenue stabilizes and the various productivity programs are fully enacted. 

Furthermore, with the dramatic improvement in free cash flow generation to $4 billion to $5 billion per year, Hewlett Packard has quickly restored its balance sheet and plans to be net debt free by the end of 2013. With this balance sheet and free cash flow turnaround, management and the board expect to focus on enhancing shareholder value via increased share buybacks and dividends.Trading at 7x earnings and less than 10x free cash flow, Hewlett-Packard share repurchases become highly accretive to shareholder value.

The Hewlett-Packard turnaround is remarkable and came much sooner than expected. We are comfortable buying at least a partial position right now, with the hope of adding to it at lower levels in the event of a pullback.  

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