HP likes to describe itself as the original Silicon Valley Startup. Founded in 1939 but split in 2015, we are looking at the printing and personal systems side of the two HP related companies.
What Are HP Up To?
It might seem odd to ask what such an old and well-known brand is up to, but since the company split they have been given the freedom to grow their hardware offering.
Source: HP Q2 2020 Presentation
The easiest way to breakdown any company is to use their language, it makes it simpler when it comes to understanding how they make their money and where the issue could be.
At the highest level, HP is broken into two halves, the personal computing and devices side of things and printing.
Unsurprisingly the money with the printing business is largely driven by supplies and ink. Those £9 ink refills plus shipping is making someone rich after all. Within the printing side of the business, HP has the new 3D printers. 3D printing isn’t just the hardware either, it includes supplies and support.
The personal computing space is dominated by their notebook/laptop ranges, which is the likely candidate for why you see the HP brand each day. Alongside this is the peripherals like monitors, keyboards, and the other bits you can spill your coffee over in the morning, this is all part of the “personal systems” side of the business.
How Has COVID-19 Impacted HP?
As expected supply chain issues have been the biggest pain point for HP, given the Eastern world was impacted by COVID-19 first, they felt the pain ahead of other industries.
However, the shift to work from home has spiked the need for printers, supplies, and new laptops. As such HP has been trying to load up their inventory (they never want it to be as high as it is right now) to try and counteract any more supply issues during the pandemic.
Source: HP Q2 2020 Earning Summary
The good news about seeing the Q2 summary is this appears to be the worst of the impact. While the situation is being monitored, HP is well stocked to limit any more disruptions to their supply lines, which also means they can reduce any ordering in Q3 and focus on selling existing inventory and R&D.
While Q2 has been a slump, and Q1 saw some impact, the real issues were linked to supply and demand. Rather than a fundamental issue with the business.
How Do HP’s Fundamentals Look?
I promised I wanted to look at an undervalued company, it should be no surprise that HP is currently cheap relative to the rest of the market, while still be a strong financial powerhouse.
Source: Genuine Impact
Let’s breakdown the key figures and see what story is inside, I’ll be focused on the quarterly figures and I’ll point it out if I change to annual. With $12.4bn in revenue and a Price to Earnings ratio of 8.21x, HP is an oddity in its size and relatively cheap price.
Breaking down that revenue we can see where HP has some room for improvement. The disappointing aspect of HP’s operations is the cost of revenue, in my mind, this is what is holding them back from becoming one of the great companies to invest in. A gross margin of 19.01% is horrifically low and makes it amazing they can even generate a profit. The profit margin is also a disappointing figure coming in at only 5.36%.
With such a large range of products offered we can find out the top-level margins but this is a very competitive space. Printing is the real winner here, this is driven by reoccurring purchases rather than meaningful innovation or IP
Source: HP Q2 2020 Presentation
In terms of Earning Per Share (EPS), we have a respectable 2.06x. For a company of HP’s size this is good to see but looking into their history they have been involved in heavy share buybacks, something I will touch on later.
The other value metrics, we have the cash to book ratio of 3.20x, but a book to share -0.84x and price to book of -20.11x. This raises some questions around their debt and liabilities. The debt to equity ratio is currently sitting at -29.05x. HP has a very interesting approach to cash and debt.
Source: HP Q2 2020 Presentation
They have always run a deficit of cash compared to their current debts. Only a few weeks ago HP confirmed another debt raise to pay off the due senior notes, while the new notes are being locked in at a lower percentage around 2-3%, they don’t appear to be paying off any debt rather they are always extending their credit.
The debt to assets percentage is always over 100%. For the past four quarters, it has bounced around 102% to 105%.
Having looked at the short term numbers, due this year, we have $19.6m available to go out but $25.2m is due, and HP is keeping their free cashflow protected. This explains the new notes and financing being issued.
Long term debt is very manageable with HP’s balance sheet, but it’s the short term accounts payable which are eating away at the business (money they owe to their suppliers.)
What About The Future?
The sell-side analysts aren’t singing HP’s praises but they aren’t off-put either.
Source: Genuine Impact
Most of the sell-side analysts are recommending a hold, given the debt juggling HP is currently managing and the current distribution issues, it’s no surprise they have taken a wait a see approach.
Then why do I consider this an investment that will pay off in the future?
Source: Wallmine
HP has been paying out since 1996 with a dividend, recently this dividend has been growing as they seek to transfer more wealth back to the shareholders.
I mention share buybacks, and this ties back to what has HP been doing with their money.
Source: HP Q2 2020 Presentation
The buyback scheme is slowing down but the management team at HP still have an objective to return cash to shareholders. HP has always sat with a comfortable $4-6bn in free cash, rather than buying back shares they want to increase the dividend.
we do plan to be active, returning at least 100% in this fiscal 2020 year. For 2021 and beyond, we remain committed to the 100% of free cash flow unless there’s a better returns-based opportunity
HP’s CFO when asked if they are returning 100% of free cash flow to investors in 2020 and 2021.
While this is under review and HP has withdrawn their forecasts due to COVID-19 they do have a plan in place to increase the long term rewards by being an HP shareholder.
Summary Pros
- Strong financial balance sheet
- Undervalued compared to the market, especially the industry
- Large and stable company, a no thrills long term buy
- Buybacks are slowing down in favour of dividend payments
Summary Cons
- Short term logistic issues and mismatch between debt and income
- Competitive space has squeezed margins, not a lot of wriggle room in the profit margin
- Not an innovator and dependant on slower-moving hardware sales
- Dependant on 3rd party suppliers for their products with no plan to centralise more of the business
- Focus on shareholder benefits could be at the expense of the long term safety for the business
My Thoughts?
HP isn’t typically the type of business I would invest in. It’s a large slow-moving fairly defensive business. They are running at a discount and we know Q3 is going to be better but still slow, this gives us a cheaper entry point.
Long term the increased dividend, which is already at 4.10%, will make this even more attractive. While the share price growth and revenue forecasts are average, I like the look of this business as a dividend machine more than anything.
I think HP is a nice source of future dividend in a portfolio, cheaper than expected with a predictable recovery incoming, it’s not going to turn into a ten times return, but will slowly payout over time.
What do you think? Is HP something you have looked at or interested in? I’m always keen to hear your thoughts!
Thanks for reading and stay safe.