Summary
- HP Inc. is a worldwide provider of personal computing and devices.
- Q4 experienced headwinds due to weak demand.
- Long-term fundamentals paint a pretty solid picture.
- The company is implementing a three-year efficiency plan.
Future Ready is the three-year efficiency plan that HP Inc. ( HPQ ) is implementing. On the business side, the company will have to guarantee a new economic sustainability capable of countering the double-digit decrease that is marking the revenue and also the profit ratio.
Ensuring growth through digitization, operational excellence, and portfolio optimization are the three founding pillars of the new path undertaken by the company.
But will it be enough to prevent an important downtrend that seems to have begun in the last 2022 quarters?
Analyzing the company fundamentals, we can see that these represent a solid foundation with constant revenue growth of 4.5% on an annual basis and above all, 5.4% of EBIT (since 2016). The Free Cash Flow per share records an annual growth of 13.8% and underlines the company's great ability to transform profits into cash flow which is then used to create shareholders' value (both as a dividend and as an investment for future growth).
The latest efficiency plan implemented by management is coming to an end this year and, if we look at the targets set, we can say that has been fully achieved. This fact gives us confidence that the next plan, even if very aggressive, can be implemented. With a share price valuation that seems attractive and a fairly stable dividend yield, to date, of 3.9%, I believe that an investment in HPQ can produce good results in the long term. My rating is Buy.
General Overview
HP Inc. is a worldwide provider of personal computing and devices, printing products, and related services.
The customer base is very diverse as it is made up of both individuals and both small and large corporate and even governmental organizations.
The company divides its profit centers into two main segments Personal Systems and Printing.
The Personal Systems segment consists of notebooks, desktops, workstations, displays, and peripherals but also software and post-sale services.
The Printing segment consists of all printer solutions at both B2C and B2B level
In 2022 the company acquired Poly , a worldwide provider of videoconference solutions. The acquisition, of a strategic nature, aims to complete the range of services offered by HP on the market in terms of improving productivity at work.
Financial & Highlights
Revenue and Profitability
The orange bars show the Revenue trend from 2016 to today. Revenue has grown at an annual rate of 4.5% ((CAGR)) and this represents a good result. In terms of profitability, EBIT grew slightly more (5.4% per year) and stood at 8.6% in 2022, down compared to 2021.
Going into the details of the Quarters starting from 2020:
We can see how the bars represent the Revenue and the EPS in absolute value and these record a fairly stationary trend. What conveys some concern is the growing trend of both Revenue and Earnings (the growth is represented by the lines in the graphs). We can see how starting from Q2 and Q3 of 2021 growth began to reverse until reaching a negative figure for the last quarter of 2022 (-11.2% in revenue and - 9.6% in EPS). These latest data are not particularly encouraging but above all the downward trend that persists from some quarters now indicates a systematic trend. The company also expects a decline in revenue in 2023 by an order of magnitude of -10% mainly due to a drop in demand.
Free Cash Flow, Dividend & CapEx
The yellow bars represent the EPS trend over the years on an annual basis these have grown, for various reasons, by 12.3%. The blue bars instead represent the Free Cash Flow per share and these also grew by 13.8% on an annual basis. This figure underlines the company's great ability to transform profits into operating cash flow available for shareholders or investments for growth.
The gray bars represent dividends. These also grew on an annual basis by 12.2%. We can see how the gray bars are largely supported by the yellow and blue ones and this underlines a virtuous management of profits in terms of cash flow creation and long-term sustainability of the dividend. The (current) dividend yield of 3.9% also represents an element of attention from any investor.
Ultimately, the orange line represents the CapEx report on depreciation and we can note an interesting fact, namely the trend reversal in 2022, going from a value that had stabilized below the unit to a value of 1.43 in a sharp increase. The company 2022 invested part of the profits differently from the past. We will see in the next paragraph the plans in place that justify this reversal of strategy.
Value creation plan
Listening to the last earnings call I can underline:
The cost actions of our Future Ready plan will generate at least $1.4 billion in gross annual run rate structural savings by year-end fiscal year '25. They will allow us to mitigate near-term market headwinds, mitigate softness in the core businesses; and just as importantly, to maintain investments in long-term growth.
The company is aware that the headwinds will continue into the next year and has defined a three-year strategic plan to counteract the decline in margins and perhaps also in revenue. The first thing that catches the eye is the order of magnitude of the $1B investment which is a really important figure and also the total headcount reduction which represents about a 10% reduction (today there are 58,000 employees worldwide).
The target of this three-year plan is to produce on an annual basis (from 2025) a run rate savings of $1.4B where in terms of the impact we have: digital transformation (with process automation), OpEx (lean processes with scale economy) and portfolio optimization (SKU reduction and lean products management).
This is certainly a large-scale strategic plan from all points of view: starting with the investments necessary for the implementation and ending with the social impact on the employees.
Will the company be able to implement all of this?
At the moment I have no elements to articulate a negative answer also because the company is coming out of an equally aggressive plan that began 3 years ago and whose objectives have all been achieved and exceeded as we can hear from the last earnings call :
Fiscal year '22 also marked the completion of our three-year value creation plan, and we exceeded all the key targets we set. In addition to delivering on our financial commitments, the plan drove important investments in our future. Most notably, we invested in our digital infrastructure to begin replatform in the company. And we invested in both R&D and M&A to accelerate the growth of our businesses. These investments have strengthened our resilience and positioned as well for the volatile market ahead.
Valuation
Earnings Power Value Model
Assuming that the cash profit remains constant over the long term, I use the EPV (earnings power value) method to calculate the share price
The method starts with EBIT. The second step is to add depreciation and amortization and then subtract stay-in-business CAPEX.
The result is the Cash Trading Profit
I then subtract the taxes by calculating the amount using the actual tax rate that the company pays.
The result is the After-Tax Cash Trading Profit
At least to calculate the total company enterprise value I divide the After-Tax Cash Profit by the interest Rate I define as fine for this kind of Company (HPQ could be in a difficult market moment so I decided to use 12%)
The result is the Total Company Earnings Power Value. Dividing the result by the total number of shares we find the value per single share.
The table below shows the calculation for HPQ
EBIT | 5,394.00 |
Dep & amort | 552.00 |
CAPEX | -791.00 |
Cash Trading Profit | 5,155.00 |
TAX | 27.90% |
TAX | -1438.25 |
After TAX cash profit | 3,716.76 |
Interest Rate | 12% |
EPV | 30972.96 |
share in issue | 980 |
EPV per share | 31.6 |
$31.6 represents the share price valuation using the EPV method. If we compare the data with the current market price ($26.5) we see that the current price could be seen as cheap
FCF/Share Model
To define a maximum buying price, I use also a formula based on FCF/Share and interest rate.
The formula is:
Maximum buying price = Cash profit per Share/interest rate - 20% (safety discount)
If TTM Cash Profit per share is $3.54
Interest Rate=inflation Rate = 7.75%
Maximum price before Safety discount = 3.54/7.75%= $49.9
The maximum price at 20% discount = $41.5
Under the FCF/Share analysis, it seems that the actual price of $26.5 is cheap.
Peer Comparison
To compare HPQ with competitor companies in the Technology Hardware, Storage, and Peripherals sector I have defined the following peers:
- Dell Technologies Inc. ( DELL )
- Canon Inc. ( CAJ )
- FUJIFILM Holdings Corporation ( OTCPK:FUJIY )
- Lenovo Group Limited ( OTCPK:LNVGY )
- Xerox Holdings Corporation ( XRX )
Using Seeking Alpha's Quant Ratings we have a 'Hold' verdict related to the 'Hold' of the others company.
Concerning the overall Quant Rating, it seems that even the competitors are not experiencing a particularly brilliant moment and this could be traced back to weak market demand, for HPQ.
Going into the merits of factor grades, we can see how HPQ is the best in terms of profitability and also in terms of valuation, we can underline how the quantitative assessment made in the previous paragraph is also confirmed in comparison with the competitors. The company appears to be affordable.
The worst results concern growth, momentum, and EPS Revision, and we underlined that growth has reversed and that extraordinary restructuring plans have become necessary to resume a virtuous path over the next 3 years.
Risks
Personal System
Total units are down 21% y/y, consumer revenue is down 25% y/y and commercial is down 6% y/y - these are very explanatory metrics of a very tense market condition. The personal systems sector with the consumer part (also notebooks revenue down 23% y/y) represents an element of strong risk in terms of revenue and profitability as personal systems represent 70% of HPQ's total business and therefore a decline so important requires extraordinary attention and disruptive actions to reverse course.
Future Ready implementation plan
The three-year efficiency plan includes a minimum target of 40% as early as 2023. This is a truly ambitious target taking into account all the actions that will have to be undertaken. The plan itself represents an element of risk but also the target of 40% in one year represents a further element of strong risk.
Conclusion
Hp Inc. has grown (from 2016) at an annual rate of 4.5% ((CAGR)) in Revenue and an annual rate of 5.4% ((CAGR)) in EBIT. EBIT Margin stands at 8.6% (2022) and historically the figure represents the second peak in 7 years. We cannot claim that the company is not in good shape. The long-term fundamentals depict good management and above all an excellent ability to convert profits into cash flow and also to disburse a respectable dividend (3.92% dividend yield).
The main concerns concern the revenue trend of the last 2022 quarter where we have witnessed a worrying drop in sales and also in profitability. The forecasts for 2023 are equally negative and this general picture has required the implementation of a three-year efficiency plan. The implementation of the plan should allow the company to emerge unscathed from this turbulent period. With a share price that seems to be cheap, my rating is Buy.
For further details see:
HP Inc.: How To Speed Up And Be 'Future Ready'