Hewlett-Packard's Detractors Ignore Positives

10/25/2010


  Recent Price
$43
  Dividend
$0.32
  Yield

0.7%

  P/E Ratio
12
  Shares (millions)
2,376
  Long-Term Debt as % of Capital
22%
  52-Week Price Range
$54.75 - $37.32

There has been no lack of Hewlett-Packard ($43; HPQ) critics since CEO Mark Hurd resigned in August after allegedly falsifying expense reports as he tried to woo an outside contractor. “The H-P board just made the worst personnel decision since the idiots on the Apple ($309; AAPL) board fired Steve Jobs many years ago,” said Oracle ($29; ORCL) CEO Larry Ellison. Investors expressed their displeasure by driving down the stock 10% immediately following the announcement.

IBM’s ($138; IBM) chief executive, Samuel Palmisano, slammed H-P for lavishing Hurd with a severance package worth about $35 million and questioned the wisdom of H-P forsaking organic growth (research and development represented just 2.5% of sales in fiscal 2009 ended October, versus 7.3% in fiscal 2002) in favor of splashy acquisitions.

Nearly two months after Hurd’s ouster, H-P named a replacement, Leo Apotheker, a veteran of software maker SAP ($51; SAP). Again, Ellison blasted the decision. Again, H-P’s stock slumped. The hiring bewildered many analysts, partly because Apotheker called software the glue holding H-P together. Software generated just 3% of H-P’s revenue and 5% of profit in the nine months ended July.

While much of the criticism H-P faces is well-founded, the company is not without fundamental strengths — and its shares are extremely cheap. We rate H-P a Buy and Long-Term Buy.

Value play

Down 17% for the year, H-P trades at 12 times trailing earnings, 23% below its five-year average P/E ratio. H-P is also sharply below five-year averages for trailing price/sales (21% discount), price/cash flow (36%), and price/book (16%) ratios. At eight times estimated earnings for fiscal 2011, the stock trades at a 17% discount to the average computer-hardware stock in the S&P 1500 Index.

The stock price seems unduly cheap considering H-P’s strengths. Operating profit margins have widened in each of the last four years. Funding for acquisitions comes from H-P’s sturdy balance sheet, replenished with $7.58 billion in free cash flow in the 12 months ended July. H-P grew per-share earnings 23% over the last four quarters, and consensus estimates project 10% to 15% growth over the next year.

Long-term risks include H-P’s reliance on personal computers (PCs), which generated 33% of sales in the nine months ended July. The future of the PC suddenly looks vulnerable, given the rise of smart phones and tablet computers. The $1.2 billion acquisition of Palm lets H-P supply both the hardware and the software for its own phones and tablets. Rival smart-phone makers enjoy a big head start, but the scale of H-Ps other segments allows the company to sacrifice profit margins in an effort to take market share.

Conclusion

October-quarter results, due Nov. 22, will be scrutinized closely. The consensus projects 11% higher per-share profits on 6% sales growth, and estimates have edged higher in recent weeks. An annual report for Hewlett-Packard Co. is available at 3000 Hanover St., Palo Alto, CA, 94304;
(650) 857-1501; www.hp.com.

HEWLETT-PACKARD
Quarter

    Per-Share
     Earnings*

Sales
Change

      Quarterly
      Price Range

P/E Ratio
Range

JuL '10 $0.75 vs. $0.69 + 11% $52.95 -

$41.94

15 - 12
Apr '10 0.91 vs. 0.71 + 13% 54.75 - 46.46 16 - 14
Jan '10 0.93 vs. 0.75 + 8% 52.95 - 46.80 17 - 15
Oct '09 0.99 vs.

0.84

- 8% 49.20 - 42.14 16 - 14
           
Year
(Oct.)

Sales
 (Bil.)

Per-Share
Earnings*
Per-Share
Dividend

52-Week Price Range

P/E Ratio
Range

2009 $114.55 $3.14 $0.32 $49.20
-
$25.39 16 - 8
2008 $118.36 $3.25 $0.32 53.48
-
30.03 16 - 9
2007 $104.29 $2.68 $0.32 53.00
-
38.15 20 - 14
2006 $91.66 $2.03 $0.32 40.10
-
27.68 20 - 14
             
————————————————— Quadrix Scores † —————————————————
Overall Momen-
tum
Value Quality Financial
Strength
Earnings
Estimates
Performance
92 60 95 80 49 95 9

   * Earnings exclude special items.
   † Quadrix® scores are percentile ranks, with 100 the best.


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