HP Is Looking for Redemption
Oct 7th 2013 6:30PM
Updated Oct 7th 2013 6:32PM
On Wednesday, Hewlett-Packard executives will be thrown into the spotlight again at the company's analyst day. HP will host a day-long discussion of its business and financial outlook, which will likely provide investors with some better clarity on the company's future.
While HP has some exciting growth businesses, such as 3PAR storage, Vertica database analytics, and Moonshot low-power servers, many of HP's key products have had stagnant or declining sales recently. It is therefore very important for HP to show that it is close to turning the corner.
The best way it can do that is by projecting a return to EPS growth in fiscal year 2014. HP is expected to earn EPS of about $3.56 this year, down more than 25% compared to the company's adjusted EPS of $4.88 just two years ago. At a higher level, investors should also be listening for in-depth commentary on how HP's newer products are faring in the marketplace. Lastly, investors should expect an update on HP's capital allocation plan.
Last year's analyst day did not go well. CEO Meg Whitman painted a brutally honest picture of HP's challenges and made it clear that it would take five years to complete a turnaround. Furthermore, CFO Cathie Lesjak stated that EPS would fall for a second straight year, to a range of $3.40-$3.60.
Analysts and investors were discouraged by this information. HP stock dropped from more than $17 before the analyst meeting to less than $14 by the end of October. Yet as some far-sighted attendees recognized, this was probably an overreaction. Observers should have expected that fixing a company of HP's size would take a long time.
Indeed, after drifting down as low as $11.35 last fall, HP shares went on to stage a big rally, peaking just below $28 this summer. However, the stock has pulled back to around $21 since then, after the company offered a downbeat forecast on its most recent earnings call.
Earnings growth is key
HP faces somewhat higher expectations coming into this year's meeting. Earnings have dropped more than 10% in the last year, but the stock price is up more than 20%. In other words, while investors aren't expecting Whitman to say all of HP's problems are solved, they are hoping to see a return to EPS growth next year, even if it's only modest growth.
This should be an achievable goal. First, the pace of HP's revenue decline is expected to moderate from this year's high-single-digit rate. Second, HP is finally starting to see the benefit of its cost-cutting initiatives, which were first announced in May 2012. If HP's earnings were to continue falling next year, in spite of these cost cuts, it would cast serious doubt on HP's ability to recover.
Looking for goodies
As an HP investor, one of the things I am most interested in hearing about is the company's capital allocation policy. For more than a year, HP has directed the vast majority of its free cash flow to debt reduction. This was a very sensible move, as hefty share repurchases and several big acquisitions had left HP's balance sheet looking grim.
But HP is now within a few months of hitting its zero net debt target. Furthermore,Whitman discussed the possibility of small acquisitions on HP's most recent earnings call. Given HP's bargain valuation, investors should be looking for HP to return more cash to them through dividends and/or share repurchases.
An immediate dividend increase may be too much to hope for, as HP already hiked its dividend once this year. Still, it would be good to see a commitment to bigger increases in the future. While HP's dividend already yields 2.7%, the company is only paying out about 15% of free cash flow. HP thus has the financial capacity to pay a much bigger dividend, which would give long-term shareholders an incentive to stick around.
Foolish bottom line
As with any technology company, the key to HP's success is constantly developing the next set of innovative products. Recently, HP has had trouble doing that. That could be bad news for investors, but it may also represent an opportunity.
Some of HP's newest products seem quite promising, and if HP can execute well, then the stock could bounce back in a big way. In the meantime, HP is generating $7.5 billion in annual free cash flow. This could support an even bigger dividend, and higher share repurchases, both of which would benefit shareholders.
Learn more about dividends
HP has the potential to be a dividend powerhouse, but is it the right dividend stock for your portfolio? If you're an investor who prefers returns to rhetoric, you'll want to read The Motley Fool's new free report "5 Dividend Myths... Busted!" In it, you'll learn which stocks provide premium growth and whether bigger dividends are better. Click here to keep reading.
The article HP Is Looking for Redemption originally appeared on Fool.com.Fool contributor Adam Levine-Weinberg owns shares of Hewlett-Packard. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.