2023-12-13 14:58:53 ET
Summary
- HPQ stock has seen enthusiasm fade after Berkshire Hathaway sold some of its stake.
- HPQ closed out the fiscal year with pressured top-line growth but resilient profitability.
- HPQ aims to return 100% of free cash flow to shareholders through dividends and share repurchases.
- Investors may be underestimating the possibility of a generative AI super cycle as consumers upgrade their PCs.
HP ( HPQ ) is a typical value-investor kind of stock. The company still derives the majority of profits from printing, a sector which may be perceived to be facing secular headwinds. Berkshire Hathaway ( BRK.B ) has been selling from its stake in the company, helping to reinforce fears that this is no longer a growth company. HPQ has a solid balance sheet and aims to return 100% of free cash flow to shareholders through dividends and share repurchases. With the stock trading at a high-single-digit multiple of earnings, the story does not need to be sexy for solid shareholder returns - yet a generative AI supercycle may be on the horizon. I reiterate my buy rating for the stock even as headwinds persist.
HPQ Stock Price
After experiencing some excitement in 2022 following news that Warren Buffett’s company had purchased a stake in the company, HPQ has seen that enthusiasm fade. The stock has still delivered solid returns in 2023 in-line with its earnings yield.
I last covered HPQ in November 2022 where I rated the stock a buy, noting that investors could purchase the stock at lower prices than Warren Buffett. While the stock is up slightly since then, it has greatly underperformed the S&P 500 market index. Stay patient here.
HPQ Stock Key Metrics
In its most recent quarter, HPQ closed out the 2023 fiscal year with pressured top-line growth but resilient profitability.
HPQ is mostly known as a printing company and the results validate that - printing made up 32% of overall revenues but 57% of operating profit.
Despite revenues declining 6.5% YoY, HPQ was still able to deliver 9.8% YoY growth in non-GAAP EPS.
It is notable that in spite of a weak PC market, which caused revenue to decline 8% YoY, HPQ was still able to drive stronger operating margins due to execution on driving down logistics costs.
Printing, which may be perceived to have more secular headwinds, was more stable at just 3% YoY declines in revenue.
We can see below that the company drove the non-GAAP EPS gains mainly through increasing earnings instead of share repurchases.
HPQ acquired Poly in 2022 and in turn spent 2023 bringing down leverage. The company paid down $1.6 billion in debt in the year, with leverage settling just at the high end of their 1.5x to 2x debt to EBITDA target.
HPQ generated $3.1 billion in free cash flow for the year, a decline from the $3.9 billion generated last year.
We can see below that whereas the company spent $4.3 billion on share repurchases in 2022, the company barely repurchased any shares in 2023. I expect the company to resume buybacks in 2024.
Looking ahead, HPQ has guided for up to 12% YoY growth in non-GAAP EPS for the full-year. Given the company’s guidance for the first quarter, it is clear that management is projecting substantially stronger results in the second half of the year.
On the conference call , management reiterated their confidence in their long term guidance given in October. Management had guided for low-single-digit revenue growth and high-single-digit EPS growth over the long term. I note that this guidance appears to be before accounting for share repurchases.
Management appeared optimistic that generative AI may “start a new cycle of market expansion and refresh,” further sharing their belief that it can “double the overall PC category growth rate over the next three years.” This projection looks reasonable and HPQ may see a surge in earnings when it takes place. Management reiterated their commitment to return at least 100% of free cash flow to shareholders, noting that they expect to resume share repurchases in the first quarter.
As I noted above, it may prove difficult for management to meet full-year guidance given that they are factoring in a material macro recovery in the second half of the year, though perhaps generative AI may be a visible catalyst. It is possible that full-year guidance is already incorporating the benefit from share repurchases.
The Generative AI Supercycle
HPQ has been in the news for the better part of the last several months due to Berkshire Hathaway consistently trimming their stake. On the flip side, Morgan Stanley recently upgraded the stock due to forecasts for a recovery in the PC market. Who’s right? HPQ does not appear to be a typical long term growth stock that Warren Buffett is famous for owning, though it does fit the bill in terms of dividends and share repurchases. Printing faces digital headwinds and the PC market is heavily saturated, not to mention that Apple ( AAPL ) has been taking market share as well . Yet the stock recently traded hands at under 9x forward earnings, making these concerns seem less relevant.
Management has already committed to returning all cash to shareholders through share repurchases and dividends, and they have a track record of doing that. That might not be the most intriguing catalyst, but in my view it is the tried and true solution to garnering higher stock valuations over time. If the company could deliver on management’s long term guidance for high single-digit earnings growth, then I could see the stock eventually trading up to 13x to 15x earnings. The most likely catalyst would be a generative AI “supercycle” as consumers seek to purchase computers with generative AI capabilities. Between the rising use cases and increased availability, I could see that supercycle taking place over the next handful of years.
Admittedly, the stock faces difficulty in achieving that projected mature valuation due to negative investor perception of printing and PCs. Even if the company fails to deliver earnings growth, the 11% earnings yield may be enough to deliver market-beating returns. The key risk is quite visible: it is possible that the slow growth rates eventually turn negative, perhaps due to an accelerated shift away from printing or pricing pressures in the PC market. The company’s leverage position looks reasonable on the assumption of some growth, but could quickly become stretched if growth turns negative. It is possible that investor fear about the possibility of growth turning negative may prevent valuations from moving higher than 10x earnings, even if such fears prove unsubstantiated. I reiterate my buy rating as the valuation looks compelling even ignoring the possibility of a generative AI supercycle.
For further details see:
HP Inc.: Warren Buffett Is Selling Ahead Of The Generative AI Supercycle