2023-11-28 03:17:50 ET
Summary
- HP Inc. experienced stagnation over the past year due to excessive spending on buybacks and a deal for Poly in 2022, leading to increased debt.
- Despite a decline in sales, margins improved, and the company expects revenue growth to return in the near future, while debt has come down in 2023.
- HP's stock price has fluctuated but remains cheap, and the company has made efforts to reduce debt and improve cash flow.
In June, I issued a few cautionary words, warning for stagnation in the case of HP Inc. ( HPQ ) . The company has benefited greatly from the pandemic, but excess earnings were spent on large share buybacks and a deal for Poly, actually making the business indebted as the inevitable downturn, or at least correction, arrived.
Stagnation could be expected, and while shares look cheap, it was the leverage and long-term commodity-like markets which warranted a below-market multiple.
After a very tough 2023, with sales down quite a bit, but margins up, the prospects for revenue growth to return are good, as this potential growth, deleveraging and a dirt cheap valuation improves the risk-reward here.
Creating perspective
Pre-pandemic, HP was a somewhat stagnant business whose shares traded around the $20 mark. The pandemic induced the work-from-home trend, triggering massive demand for printers and PCs, as shares rose to the $40 mark on the back of this trend and the involvement of Berkshire Hathaway (BRK.A) (BRK.B) in the form of a stock investment.
Pre-pandemic (for the year ending October 2020) this was a near $57 billion business that posted operating profits of $2.8 billion. Revenues rose 12% to $63 billion and change in 2021, with margins up 2% points, as earnings rose to nearly $4 per share.
Originally guiding for 2022 earnings to rise from $3.79 per share in 2021 to $4.17 per share in 2022, the reality was that much of the guided earnings growth was the result of share buybacks, with actual dollar earnings seen rather flat, or even down a bit. While the company hiked the earnings guidance alongside the second quarter results, it was a big profit warning in the third quarter which disrupted the post-pandemic growth trend.
In the end, 2022 sales actually fell a percent to $63 billion, as adjusted earnings still came in at $4.06 per share. Amidst worsening trends in the second half of the year, the company initiated a $1.4 billion cost savings program through 2025 and saw 2023 earnings down to $3.20-$3.60 per share, despite the contribution of Poly.
First quarter sales for 2023 fell 18% despite the contribution of Poly, although shares falling to the high twenties tempted me to initiate a modest position. In May, HP announced a 22% fall in second quarter sales, as margins held up rather well. The company narrowed the full-year earnings guidance to $3.30-$3.50 per share, as net debt ticked down to $8.7 billion, still a very substantial number, with improvements due to a lower pace of share buybacks.
With sales coming in softer than anticipated, margins were stronger than expected, resulting in an overall rather neutral impact on earnings. As the situation was stabilizing, cheapness was seen with shares trading around the $30 mark in early June, but there were few reasons to get excited about, other than the cheapness argument. This comes as I believe that HP is positioned as a GDP business at best, perhaps growing at a slightly slower pace.
Trading Range Bound
Since June, shares initially rose to the $33 mark over the summer, before falling to $25 and change in September, now having recovered to $28 per share and change.
In July, HP actually used some of its cash to buy back debt, in fact, it bought back a billion in debt, in some cases substantially below par. Towards the end of August, HP posted better third quarter results with sales down 10% to $13.2 billion (amidst easier comparables), adjusted operating profit margins were down 60 basis points to 8.8% of sales, as net debt ticked down further to $8.5 billion. Despite some sequential improvements, full-year earnings per share were now seen down to $3.23-$3.35 per share.
In October, HP provided an initial outlook for the fiscal year 2024 results (ahead of the release of the 2023 results). The company guided for earnings between $3.25 and $3.65 per share, as the modest hike in the earnings guidance was backed up by a $200 million increase in the cost-saving targets, giving management confidence to hike the dividend by 5% to $1.10 per share.
In November, HP posted its 2023 results as fourth quarter sales fell 6.5% to $13.8 billion, with full-year sales down 14.6% to $53.7 billion, coming in below pre-pandemic levels, despite the passage of time and inflationary pressures. The company posted strong adjusted operating profit margins of 9.0% for the final quarter, actually up 140 basis points on the year before. This makes that despite a 15% fall in full-year sales, adjusted operating profit margins were dead flat for the year (and much higher than pre-pandemic levels), as adjusted earnings came in at $3.28 per share.
Net debt plunged to $6.3 billion in what typically is a very strong quarter from a cash flow perspective, which looks rather compelling. In fact, net debt is rapidly coming down, no longer being a major cause of concern for me here. While no formal revenue guidance for 2024 has been issued, modest earnings growth is seen, although GAAP earnings are seen around half a dollar lower.
And Now?
Trading at $28 and change, HP trades at just over 8 times adjusted earnings, all while net debt has come much more under control here, after a pause in share repurchases, as the 2024 guidance calls for modest earnings per share growth.
By now, the situation looks a bit better than was the case this time last year. Over the past twelve months, the company has seen leverage come down a bit, and while earnings still trend at similar levels, the downward trajectory has ended, with growth seen again in the fiscal year 2024.
Moreover, the sluggish share price performance and dividend hike pushed up the yield to near 4%, albeit it lags risk-free rates. The reality is that while sales were soft in 2023, softer than perhaps anticipated, the opposite is the case of margins, which is a big achievement.
Amidst all this, there is much to like from a dirt-cheap valuation and deleveraging point of view, with more cash flow earmarked for investors in 2024, after a year of deleveraging in 2023. That is about the good news, as the company of course does not have great long-term growth prospects, notably in printing, which is the smaller but more profitable segment.
All in all, I am happy to hold onto my shares here, but I am in no rush to alter my position, even if valuations look very compelling here.
For further details see:
HP Inc.: Cheap And Improving