HP Inc. (HPQ, Financial) announced its Future Ready Transformation Plan in November 2022, in conjunction with its fourth quarter and full-year results for fiscal 2022 (its fiscal year ends on Oct. 31).
HP was one of the winners when Covid-19 struck. Thanks to an exodus of employees heading to home offices, computer and peripheral companies enjoyed a boost in sales. However, those gains were short-lived and returns fell back in line with those of the past.
Now, HP needs to do something to get investors interested in the stock again and return the company to growth. I think the company is doing a great job with its strategic shift so far; here's why.
About HP
HP began its business life as Hewlett Packard, which grew into a massive computer, peripherals and information technology company. In 2015, the company split in two, becoming HP and Hewlett Packard Enterprise Company (HPE, Financial). The former became the computer and peripherals company while the latter became an information technology company.
This slide from HP’s fourth-quarter 2022 investor presentation outlines the company’s main lines of business, its key segments and the geographical origin of its net revenue:
Revenue, Ebitda and earnings per share came down as the pandemic eased and demand for HP products softened. This chart shows its earnings per share without non-recurring items over the past decade:
HPQ Data by GuruFocus
Future Ready
To get earnings growing again, the Future Ready strategy calls for cost reductions and more emphasis on the company’s faster growing segments. Cost cutting is expected to deliver $1.4 billion in annual savings, starting with fiscal 2023, which ends on Oct. 31. As outlined in the fourth-quarter investor presentation, the savings are expected to come in three areas:
- Digital transformation: “Unlock efficiencies with automation and process management.”
- Portfolio optimization: “Focus on businesses where we can be #1 or #2 over the next three years.”
- Operation excellence: “Streamline cost structure within core businesses to drive scale and efficiency.”
Because of these initiatives, the company expects to cut its current headcount of approximately 58,000 employees by 4,000 to 6,000 by the end of fiscal 2025. It will take a onetime $1 billion charge for restructuring and other costs.
The growth portfolio, which had an excellent fourth quarter, includes peripherals, gaming and hybrid work solutions. Areas that have been sluggish include its consumer PCs, printer and notebooks.
Competition
Competition varies by segment, but all the company's segments are highly competitive. For personal systems, it competes with Lenovo Group Limited (LNVGY, Financial), Dell Inc. (DELL, Financial) and others. Its main competitors in the printing segment are Canon Inc. (CAJ, Financial) and Lexmark International Inc. (LXK).
This chart from the 10-K for fiscal 2021 shows HP lagging the S&P 500 Information Technology Index, but generally matching the performance of the S&P 500 Index:
Fundamentals
Overall, the company receives a high GF Score of 87 out of 100:
The below chart from GuruFocus breaks down HP's income statement to show how it makes its money and what its expenses are:
HPQ Data by GuruFocus
HP carries what I think is a manageable amount of debt. Its interest coverage ratio is 14.54, its debt-to-revenue ratio is good at 17.49 (October 2022 short- and long-term debt totaled $11.014 billion, which is far lower than its revenue of $62.983 billion). Finally, its Altman Z-Score is 2.08, which puts it in the grey zone and is substandard but not dangerous.
Its profitability is adequate, with operating and net margins of 8.33% and 5.09%, respectively, that are better than averages for the hardware industry. Still, they are not industry leading:
HPQ Data by GuruFocus
Growth of HP’s revenue looks good from a three-year perspective because of the Covid-19 boost, but even over five years revenue has trended in the right direction:
Ebitda offers a similar pattern, but the ups and downs are more pronounced. Free cash flow also flourished in fiscal 2021 before normalizing in 2022.
HPQ Data by GuruFocus
HP currently pays a dividend of $0.263 per quarter or $1.052 annually. Based on the Jan. 24 closing price of $28.60, that produces a yield of 3.55%.
The company also repurchases its own shares at a faster pace than most other companies: 9.15% per year on average:
HPQ Data by GuruFocus
Combine that yield of 3.55% and the buyback rate of 9.15% per year and in theory, shareholders received a yield of 12.70% (Mr. Market doesn’t always account for this, of course). The company reports returning $5.3 billion to shareholders in fiscal 2022 through dividends and share repurchases.
That sounds attractive to me, but at the same time it reported free cash flow of $3.9 billion, which is significantly less than the $5.3 billion passed on to shareholders. Presumably, most of the difference was made up out of cash and cash equivalents, which dropped from $4.299 billion in 2021 to $3.145 billion in 2022.
Valuation
There has been softening demand for HP shares as demand for PCs has fallen. The current price is well below previous highs and the trendline:
HPQ Data by GuruFocus
The GF Value chart rates HP as modestly undervalued with a 21.61% margin of safety.
At 9.51, the price-earnings ratio is better than most of the industry. Combine that with a five-year Ebitda growth rate of 24.60% and you end up with an industry-leading PEG ratio of 0.39. That’s a third verdict of undervaluation.
Gurus
HP has the backing of a dozen gurus, many of whom had significant holdings at the end of the third quarter according to their 13F reports.
Warren Buffett (Trades, Portfolio) had the biggest position with 104,476,035 shares. They represented 10.39% of HP’s shares outstanding and 0.88% of Berkshire Hathaway’s (BRK.A, Financial)(BRK.B, Financial) 13F portfolio.
Dodge & Cox owned 54,438,979 shares and PRIMECAP Management (Trades, Portfolio) held 23,553,305 shares.
Institutional investors owned 78.85% of shares outstanding, while insiders held 0.73%.
Investors should be aware that 13F reports do not provide a complete picture of a guru’s holdings. They include only a snapshot of long equity positions in U.S.-listed stocks and American depository receipts as of the quarter’s end. They do not include short positions, non-ADR international holdings or other types of securities. However, even this limited filing can provide valuable information.
Conclusion
Maybe I’m somewhat biased by Warren Buffett (Trades, Portfolio)’s position, but HP looks like a quality company available at a favorable price (although it does not make it through the Buffett-Munger screener). And it doesn’t hurt that the company rewards its shareholders well, or that it is currently trying to implement a growth plan.
