Wednesday, June 29, 2011

3 Reasons For HP Stock, 5 Against

Hewlett-Packard (NYSE: HPQ) is opening up a hardware research and development operation in Beijing. Is this China foray a signal that you should buy HP stock? There are two reasons to buy HP stock and two against.

HP sells all information technologies to all segments. HP sells those products and services through five operating groups including:
  • Services -- systems consulting services to organizations,
  • Enterprise Storage and Servers (ESS) -- storage and computing hardware to organizations,
  • HP Software -- corporate software,
  • Personal Systems Group (PSG) -- personal computers and related systems, and
  • Imaging and Printing Group (IPG) -- printing and scanning hardware.
And it sells them, in a targeted way, to individual consumers, small- and medium-sized businesses (SMBs) and large enterprises, including customers in the government, health and education sectors.

Why buy? Here are three favorable factors:
  • Good five year income statement. HP has posted respectable financial results. HP's revenues are a whopping $128 billion, growing at 7.8% average rate since 2006 and its net income of $9.2 billion has risen at an impressive 29.6% average annual rate over the last five years.
  • Growth in Economic Value Added. HP is generating a positive return for its capital providers. After all, it’s producing slightly positive EVA Momentum, which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales. In 2010, HP’s EVA momentum was 1%, based on 2009 revenue of $114.6 billion, and EVA that grew from $1.1 billion in 2009 to $1.7 billion in 2010.
  • Expansion into China. HP plans to open a research center in Beijing in 2011 and will hire an unspecified number of engineers to develop global storage and networking products. HP gets 12% of its sales, $3.7 billion worth, from so-called BRIC countries -- Brazil, Russia, India, and China. But HP is not new to China. It began operating there in 1985 and about 20,000 HP workers call China home. This is good news but would not make a huge impact on overall sales.
Why steer clear? Here are five reasons:
  • Weakening balance sheet. But its balance sheet has deteriorated over that time. For example, its cash balance has declined at a 9.7% annual rate from $16.4 billion in 2006 to $10.9 billion in 2010. During that same period its debt has skyrocketed at a 57.3% annual rate from $2.5 billion to $15.3 billion. And in the last year, its stock has lost 23% of its value to $72.8 billion.
  • Poor second quarter performance. HP's second quarter performance was disappointing. For the second quarter, HP said its earnings would be $1.08 a share -- 12.2% below analysts' estimates -- the second straight quarter HP missed forecasts, according to Bloomberg.
  • Lowered 2011 expectations. HP also slashed its full-year projections. It cut a billion dollars from its 2011 sales forecast and missed analysts’ profit projections as consumers shunned PCs and services margins narrowed. Specifically, HP announced on May 17 that its 2011 will be between $129 billion and $130 billion while EPS will be "at least $5 a share." Analysts in a Bloomberg survey estimated sales of $130.3 billion and earnings of $5.24.
  • Fairly expensive stock. And HP's stock valuation is just a little pricey — trading at a price-to-earnings-to-growth (PEG) ratio of 1.23 (where 1.0 is considered fairly valued). HP’s P/E is 8.6 on earnings expected to climb 7% to $5.36 a share in 2012.
  • Questionable CEO. Is CEO Leo Apotheker going to work out? Before arriving at HP in November 2010, Apotheker resigned as CEO of a German software maker, SAP AG. But he left amid falling sales, a union battle over job cuts and a price increase that angered customers. Will this experience help him solve HP's problems or will he end up producing the same results that prompted his departure from SAP?
The reasons not to buy HP stock outweigh the three that favor it. I would wait until this balance tilts more in HP's favor.


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