2024-01-02 10:43:39 ET
Summary
- HPQ reported 4Q23 revenue of $13.82 billion, beating estimates.
- The growth outlook for HPQ remains positive, with management reiterating their FY24 non-GAAP EPS guidance range and FCF range.
- HPQ is gaining market share, and the shift towards AI PCs and higher-value products is expected to drive growth in CY24.
Summary
Readers may find my previous coverage via this link . My previous rating was a buy, as I believed HP Inc. (HPQ) would be able to grow as guided by management. On top of the earnings growth tailwind, HPQ also had an attractive capital return policy that I was positive about. I am reiterating my buy rating for HPQ as the growth outlook remains positive, which gives me confidence that HPQ can grow its EPS as guided. The strong profit performance this quarter also supports the capital return story as HPQ continues to convert a large amount of earnings to FCF.
Financials/Valuation
HPQ reported 4Q23 revenue of $13.82 billion, down 6% vs. 4Q22, but beat consensus estimates of $13.79 billion. The beat was driven by Personal Systems Group [PSG] revenue of $9.4 billion and printing revenue of $4.4 billion. While revenue was down 6%, the upside was in the profit lines, as gross profit came in at $2.98 billion and non-GAAP EBIT was reported at $1.25 billion. The strong profit performance led management to reiterate their FY24 non-GAAP EPS guidance range of $3.25 to $3.65 and FCF range of $3.1 to $3.6 billion.
Based on author's own math
Based on my view of the business, I have increased confidence that HPQ should be able to grow at my previous estimate of 3% over the next 3 years (through FY26). In fact, with my outlook on the PC industry, I think there is a good chance for HPQ to beat my 3% estimate (which I anchored to GDP-like growth). I also reiterate my net margin estimates (recovery to FY22 margins) over the next 3 years as PC ASPs and reduced costs drive this improvement. Finally, in terms of capital returns, HPQ has historically converted ~90% of its net income to FCF, and I assume they can continue to do so for FY25 and FY26 (the FY24 estimate follows management guidance) as there are no major changes to its business. This translates to ~22% FCF yield (based on today's share price) over the next 2 years. For the HPQ forward PE assumption, I assumed the stock would continue to trade at this level as HPQ earnings growth is still elevated (driven by a recovery in margin). Historically, HPQ has traded in a tight range of 7 to 9x forward PE, so I don't think there is an argument that HPQ is overvalued on a valuation basis today.
We also remain committed to returning at least 100% of free cash flow over time, unless opportunities with a higher return on investment arise and as long as our gross leverage ratio remains under 2x EBITDA. Source: 4Q23 earnings
Comments
The macro turmoil has led to many investors getting worried about the near-term enterprise demand outlook. I believe this worry has merits, as businesses are still tight on their budget, delaying deployment, and scrutinizing projects. However, things appear to be turning positive for HPQ as demand trends in the PC market are relatively stable. For instance, PSG grew revenue by 5% on a sequential basis, which I take as a positive sign of recovery. In addition, the management team noticed that the demand for Personal Systems was showing indications of stabilization. They did not notice any changes in buying behavior or unusual demand linearity. In fact, I think there is a strong catalyst that will reignite PC demand growth: AI PCs. There is no argument that existing and future businesses will need to incorporate AI into their businesses, one way or another. The existing base of PCs does not have the required computing and processing capabilities to enable businesses to take full advantage of AI functions. As such, I see a visible path for businesses to convert their PCs to AI PCs over time. According to management's projections, the PC category as a whole should see double-digit growth in the next three years. All of these, coupled with the fact that the PC industry has gone through inventory depletion over the past few quarters, led me to further believe that the PC volume is going to see a better year in CY2024.
The other implication of AI PC increased penetration is that ASP will move upwards as well, simply because AI costs more (the parts are more expensive) and it is a premium product vs. the existing PC products. I note that PC ASP might continue to see positive growth over the medium term as management expects PC ASP to be up in FY24, despite only minimal AI PC launches. This suggests to me that the new product rollouts (ex-AI PCs) are seeing a better pricing environment, which is possibly driven by a mix shift to premium notebooks and gaming, where revenue and units grew by double digits sequentially in 4Q23.
As such, what HPQ has on hand is:
- PC demand is likely to recover as inventory has depleted over the past few quarters.
- AI PC being a strong growth catalyst over the medium to long term
- HPQ is gaining market share.
- Positive ASP movement due to pricing and mix-shift to higher-value products
With these points in mind, I am positive about the HPQ CY24 growth outlook.
Aside from the growth outlook, management execution on the profitability front was very positive as well. The reason I say this is because HPQ is gaining market share in this demand environment without pushing too many promotions and is not seeing major pricing headwinds. In FY24, management plans to keep cutting structural costs by continuing to simplify products and reducing corporate expenses. With a visible positive growth outlook combined with HPQ's strong execution in reducing costs, I reiterate my view that HPQ should have no issues meeting its growth guidance.
Risk & Conclusion
The risk is the timing of growth recovery. While I expect recovery in CY24, it might come later than expected due to various factors. For instance, if the US economy continues to be sluggish despite favorable indicators (slowing inflation and possible rates cut), it could cause PC demand to remind weak for the near-term.
In conclusion, I reiterate my buy rating for HPQ. Market stabilization and indications of PC demand recovery, coupled with HPQ's market share gain and a shift toward higher-value products, support my positive growth outlook for CY24. Management efforts in reducing the cost structure also bodes well for meeting EPS targets and capital returns.
For further details see:
HP Inc.: FY24 Growth Outlook Positive