HP has market-leading portfolios in the PC and print categories. Management believes that the company is well positioned to drive profitable growth in its core markets in the future. HP also has significant opportunities to accelerate in its key growth areas. Management also believes that HP has world-class operational capabilities to deliver on its targets and reduce its structural costs. HP also has a shareholder-friendly capital return strategy. In this analysis, I will investigate whether now is the right time to invest in HP.
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since attending the workshop with Phil Town, I have decided to make some changes to the layout of my analyses. I will perform additional calculations and also provide a brief explanation of why the company is significant to me. If you want to learn more about my company evaluation process, please visit the "MY STRATEGY" section on my website.
For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares of HP. If you would like to view the stocks in my portfolio or copy my portfolio, you can do so on eToro. Instructions on how to do so can be found here. I do not own any stocks in any of HP's direct competitors either. Thus, I have no personal stake in HP. If you want to purchase shares or fractional shares of HP, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.
The Business
Hewlett-Packard was founded in 1939 in California, United States. However, the company split into two separate entities in November 2015 (HP Inc and Hewlett-Packard Enterprise). HP Inc. is a multinational information technology company that develops PCs, printers, related supplies, and 3D printing services. HP Inc. has operations in 185 countries worldwide. HP Inc. has three reportable segments: Personal Systems, Printing, and Corporate Investments. However, the Corporate Investments segment contributes less than 0,01% of revenue. The largest segment is Personal Systems, which offers products such as commercial and consumer desktops and notebooks, workstations, and hybrid systems (including video conferencing cameras and solutions and headsets). This segment contributes 68% of the revenue. The Printing segment offers consumer and commercial printer hardware, supplies, services, and solutions. The Printing segment also focuses on graphics and 3D printing. The Printing segment contributes 32% of the revenue. The Printing segment has the highest margins, with an operating margin of 18,9%, compared to an operating margin of 6,7% in the Personal Systems segment. HP Inc. is one of the global market leaders in both PCs and printing. HP has an iconic brand as it is one of the oldest and most recognized brands in the technology industry. It is known for its reliability, quality, and innovation. The strong brand reputation helps attract and retain customers. I believe that HP has a strong brand moat.
Management
The CEO is Enrique Lores. He joined HP as an engineering intern in 1989 and held various leadership positions in the company until he became the CEO in November 2019. He earned a bachelor's degree in electrical engineering from the Polytechnic University of Valencia and his MBA from Esade Business School. Enrique Lores also serves on the Board of Directors for PayPal. He was a key architect of the separation of Hewlett-Packard Company in 2015, which was one of the largest and most complex corporate separations in business history. He was instrumental in transforming HP's cost structure, simplifying the organization, and creating the capacity to invest in innovation to drive profitable top and bottom-line growth. As a CEO, he is driving a strategy to position HP for the future by focusing on building a more growth-oriented portfolio, transforming into a more digital company, and establishing the company as the leading place for talent development. He is also known for fending off a hostile bid from Xeros Holdings, which was driven by investor Carl Icahn, who held stakes in both companies. He is not afraid to make acquisitions, as evidenced by the acquisition of HyperX. He believes that gaming and peripherals are attractive segments. He has been acknowledged by Barron's as one of the top CEOs in 2022 and has received an 80/100 employee score at Comparably, which puts him in the top 5% of similarly sized companies. I believe that Enrique Lores is the right person to lead HP moving forward. He has vast experience in the industry, a clear and bold strategy to grow HP, is unafraid of fending off hostile takeovers or making large acquisitions, and is acknowledged as a top CEO who is well-liked by his employees.
The Numbers
The first metric we will investigate is the return on invested capital (ROIC). I would like a 10-year history demonstrating a minimum annual growth of 10%. I only have data from fiscal year 2016 onwards because that's when Hewlett-Packard split its business. The numbers in the eight years of available data are fantastic. You don't often see a company that manages to deliver such a high Return on Invested Capital (ROIC). The high ROIC is probably not sustainable, as indicated by the past two years during which ROIC has decreased significantly compared to previous years. Delivering a ROIC of 40% is still very impressive, but I would like to see some signals that ROIC isn't going to decrease every year. Nonetheless, these numbers are impressive as you see few companies that manage to deliver such a high ROIC.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most significant of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. These figures look concerning as HP has only managed to deliver one year with positive equity. However, I wouldn't put too much importance on these numbers as HP has used inexpensive debt to repurchase shares. It is something that many companies have done, but it results in negative equity. Thus, there isn't much to conclude from these numbers.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins offer a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. It is not surprising to note that HP has consistently generated positive free cash flow every year for the past eight years. Free cash flow has remained relatively stable over the years despite acquisitions, a pandemic, and high inflation. However, it is worth noting that the free cash flow was the second lowest in fiscal year 2023, primarily due to macroeconomic factors. Levered free cash flow margin has also been relatively stable over the years but reached its lowest point in fiscal 2023. Free cash flow yield has consistently been high, indicating that the shares have never been excessively expensive. However, I will revisit this point later in the analysis.
Debt
Another important aspect to consider is the level of debt. It is crucial to determine if a business has manageable debt that can be repaid within a three-year period. We calculate this by dividing the total long-term debt by earnings. After analyzing HP's financials, I found that the company has 2,84 years' worth of earnings in debt. It is below the three-year threshold, which means that debt is not a concern for me.
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Risks
Based on my findings so far, I find HP to be an intriguing company. However, no investment is without risk, and HP also has its fair share of risks. One risk is macroeconomics. In its annual report, HP mentions that its business and financial performance depends on worldwide economic conditions and the demand for its products and services. For example, during fiscal 2023, HP observed continued market uncertainty, cautious commercial spending on information technology hardware, lower discretionary consumer spending, inflationary pressures, and foreign currency fluctuations. Management expects the economic and demand environment to remain challenging in 2024.
Competition. In its annual report, HP mentions that it encounters strong competition in all areas of its business activities. The markets for each of HP's key business segments are characterized by strong competition among major corporations with long-established positions and a large number of new and rapidly growing firms. The markets in which Personal Systems operates are highly competitive and are characterized by price competition and the introduction of new products and solutions. The markets for printer hardware and associated supplies are also highly competitive. Printing's key customer segments each face competitive market pressures related to pricing and the introduction of new products.
Secular declines in printing. There is a secular decline in the printing industry due to consumers shifting from print to digital formats. Thus, the printing industry experiences consistent revenue declines. S&P Global predicts that commercial printers will encounter decreasing volumes, price competition, increasing costs, and significant debt loads. S&P Global believes these challenges will continue, and in some select cases even accelerate, as printers compete for client spending, manage their own legacy cost structures, and address upcoming debt maturities. As a result of these trends, S&P Global's ratings outlook for most companies in the print sector is negative. The secular decline in printing will negatively impact HP since it is its highest margin business.
Reasons to invest
There are also numerous reasons to invest in HP. One reason is the Future Ready transformation plan. HP has introduced its Future Ready transformation plan, which consists of three pillars. One pillar is to optimize and reduce structural costs, and in its first year, HP overdelivered, leading to an increase in HP's three-year target for cost reductions. Another pillar is digital transformation, where HP is targeting additional automation and process improvements through the use of AI tools. The third pillar is to simplify the product portfolio, which will enhance agility and operating leverage. If management succeeds with their Future Ready transformation plan, HP should be more profitable in the future.
AI PCs. Management believes that the emergence of the AI PC in 2024 will initiate a new cycle of market expansion and rejuvenation. Management believes this can double the overall PC category growth rate over the next three years and stated that AI PCs are really going to have a significant impact. HP will introduce the first AI PC in the second half of 2024. While the impact will be small in 2024, they have high hopes for the future. Their expectation is that in three years, 40% to 60% of PCs will be AI-enabled.
Shareholder-friendly. HP is shareholder-friendly as they are committed to returning at least 100% of free cash flow to investors over time, unless opportunities with a higher return on investment arise, and as long as their gross leverage ratio remains under 2x EBITDA. HP has just increased its dividend by 5% and is also returning cash to shareholders through share repurchases. Since its IPO, the number of shares outstanding has decreased from 1,711 billion to approximately 988 million, indicating a 42% decrease in shares outstanding since its IPO.
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Valuation
Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 3,26, which is from the fiscal year 2023. I have selected a projected future EPS growth rate of 3,5%. Finbox expects EPS to grow by 3,6%. Additionally, I have selected a projected future P/E ratio of 7, which is double the growth rate. This decision is based on HPs historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $7,96 We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy HP at a price of $3,98 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 3.500, and capital expenditures were 603. I attempted to analyze their annual report in order to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 422 in our calculations. The tax provision was -336. We have 988,269 outstanding shares. Hence, the calculation will be as follows: (3.500 – 422 - 336) / 988,269 x 10 = $27,75 in Ten Cap price.
The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With HP's free cash flow per share at $3,00 and a growth rate of 3,5%, if you want to recoup your investment in 8 years, the Payback Time price is $28,11.
Conclusion
I find HP to be an interesting company with excellent management. HP is currently facing some short-term headwinds due to macroeconomic factors, and these challenges are expected to persist throughout 2024. However, macroeconomics will eventually improve. Competition will always pose a risk for HP, and they will need to continue innovating to stay ahead of their competitors. HP surely has a strong track record, and I don't see any reason why HP should stop innovating. The largest risk for HP is the secular decline in printing. Printing is HP's most profitable business, and while printers may continue to be relevant for a considerable period, the secular decline will impact the entire industry, as predicted by S&P Global. Thus, HP will need to grow its business in other areas to compensate for the loss in its printing segment. The Future Ready transformation plan should boost profitability for HP. However, the question remains whether it is sufficient to offset the decline in the printing segment. AI PCs will also serve as a growth catalyst for HP, but selling PCs typically yields lower margins, as previously explained in the analysis. I like that HP is shareholder-friendly and will continue to be so. They will enhance shareholder return through dividends and buybacks, which is something I appreciate. However, I believe there is too much uncertainty surrounding HP and whether they will be able to compensate for the declining printing segment. Hence, I will not be investing in HP at this time.
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