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Published: September 27, 2010
A common pitfall
companies encounter has to do with challenging marketplace
conditions, be it changing customer habits or competition from
rivals that attempt to steal away its business. Others have a
habit of self inflicting their wounds.
Changing market conditions, foreign competition, fickle
consumers -- these are conditions most investors can live with
as an excuse for poor performance -- to an extent. But when a
dominant company continually stumbles over itself because of
something as simple and within the realm of control as, say,
hiring and firing decisions, its enough to make investors head
for the exit.
But in the case of Hewlett-Packard (NYSE: HPQ), the crowd
has it all wrong. Sure, the soap-opera events surrounding the
dismissal of Mark Hurd, HP's former Chief Operating Officer,
were embarrassing for the company, but new investors now have a
chance to pick up a world-class name for a cheap price.
The most recent snafu from HP relates to the manner in which it
ousted Hurd. Apparently, he wasn't as popular inside the company
as he was outside. Investors cheered his every move, be it cost
cutting or orchestrating sizeable acquisitions, both of which
helped sales and profits move forward in impressive fashion.
Past issues have stemmed from the hiring of Carly Fiorina, a
high-profile executive from outside the company that oversaw the
ambitious purchase of Compaq Computers. Unfortunately, this move
and others did nothing to boost the share price and resulted in
her sacking within a few years. Shortly after this chain of
events, Patricia Dunn, the company's chairwoman, was fired after
it was discovered she hired private-eye firms to spy on other
board members.
Talk about internal company drama.
The reasons for the sacking of Mark Hurd are not clear and may
never be, because the board of directors did not provide a
straightforward explanation of why he was let go. Doctored
expense reports and a murky relationship with a woman who worked
on corporate events for the company were alluded to, but never
fully explained. Whatever the real reason may be, it leaves the
company without a CEO that appeared to be wildly successful to
those outside of the company.
This uncertainty has sent shares of HP to bargain-basement
levels. Communication from the board has stated that HP is not
dependent on any one individual for its success and refers to an
"HP Way" that is meant to define its culture and no-nonsense,
team approach to creating and selling technology products and
services. Despite the board's dismal track record on
communicating with the investment community, it is spot on in
this case.
Regardless of the litany of leadership drama at HP, the
company's corporate culture appears to be working. HP has been
experiencing improving demand in most of its businesses. Revenue
during its most recent quarter increased a very healthy +11.4%
and reached $30.7 billion on the back of strong trends for its
enterprise storage and servers, computers and printers. Service
growth was more modest but remained highly profitable. HP also
provided a favorable outlook. It expects full-year sales to
reach more than $125 billion and
earnings from continuing operations of around $4.50 per
share. This would represent year-over-year sales growth of
almost +10% and earnings growth in the mid-teens.
In addition to the strong
organic growth trends, HP has snapped up a number of smaller
tech rivals. Bolt-on acquisitions include data-storage firm
3PAR (NYSE: PAR), and software security providers
ArcSight (Nasdaq: ARST) and Fortify Software. Healthy
cash flow generation is being used on acquisitions, share
buybacks and to support a modest
dividend.
Favorable market tailwinds and healthy acquisition activity mean
HP is unlikely to see any serious disruption to its operations
while it searches for a successor. I've had past concerns that
the hardware (computer, printers, etc.) divisions are too
cyclical and carry low profit margins, but the company has a few
years of easy sailing as global economies recover from the
credit crisis and companies refresh aging devices to remain
competitive.
Action to Take ---> At a
forward
P/E of just over 9, investors are far too pessimistic on
HP's future. Near-term negative sentiment from the Hurd firing
isn't helping, but does offer an opportunity to pick up the
shares on the cheap. Last year,
free cash flow ran close to $4.60 per diluted share and
illustrates just how much excess capital the company generates.
This also equates to a trailing free cash flow multiple around
9. Applying a more historical multiple in the low teens off of
earnings and cash flow suggests upside of at least +40% and
doesn't even factor in annual profit growth, which should be at
least +10% for the foreseeable future. In my mind, it doesn't
really matter who the next CEO will be, or how long he or she
remains at the helm -- the stock is still a buy.
-- Ryan Fuhrmann
Contributor
StreetAuthority
P.S. -- Over the past few weeks we've been telling you
about an opportunity to protect yourself from the coming tax
hikes. Have you taken action yet? If not,
here's what you need to know to get started.
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