HP Inc.: HPQ: Short-Term PC Headwinds, Long Term Opportunity (HPQ).

HP Inc.NYSE:HPQ) is a legacy technology company that focuses on selling Personal Computers and Printers. The company is facing headwinds because of the cyclical declines in the personal computer market. Long term, however, the business stands to gain from the personal computing market’s cyclical decline. Trends such as remote working (after Poly’s acquisition, discussed later) or 3D printing are some of the most important growth trends. The global market for 3D printing was valued at $13.8 million in 2021. Forecasted To grow at a rapid rate of 20.8% compounded annual increase up to 2030. This post will cover the most recent financial results for HP and then reveal its valuation.

Fourth Quarter Financial Results

For the fourth quarter of fiscal 2022, HP posted solid financial results. Analyst expectations were $124 million higher than the revenue of $14.8 billion. However, revenue fell by 11% over the year or 8% when using constant currency. This was due to macro headwinds, which management expected.

The majority of HP’s revenue comes from Personal Systems Revenue (70%) and Printing revenue (30%). Personal Systems revenue was $10.3Billion in Q4, F22. This is a 9% decrease year-over-year but an increase of 4% sequentially on constant currency. The Personal Systems segment can be further broken down into Notebooks (46% of revenue), Desktops (17%), and Workstation & Other systems (7%).

In 2022, the market is experiencing a cyclical downturn and there has been a low demand for consumer PCs. A few factors have contributed to this drop in demand. Firstly, the lockdown of 2020 saw a significant increase in computer and gaming sales. This is because many people remained at home and the trend towards setting up home offices for remote working was very popular. Many people became “cash rich” through stimulus programs around the globe.

The environment in 2022 is quite different. High inflation and rising interest rates are putting pressure on both consumers and businesses. This is leading to higher input costs for both consumers and businesses. Despite the macroeconomic environment HP continues to innovate and will announce a new series gaming and notebook computers at the CES Event 2022.

The company also closed the $3.3B acquisition Poly, a provider video conference solution provider that provides headsets, microphones and software. The fourth quarter results also include two months of Poly derived financials. Management has stated that Poly is performing better than expected. This makes sense considering the rise in hybrid working and the solutions that make this work efficient. One study found that 63% of high-revenue growth businesses use hybrid workforce models.

A positive trend in HP’s Personal Systems division is a positive move toward more commercial business. This segment accounts for over 75% revenue. It is great to see that commercial businesses have higher average order volumes and are more consistent with repeat business, which is a good thing.

The Print segment saw revenue of $4.5 billion. This was a decrease by 7% over the previous year, or 6% when using constant currency. This decline was caused by the softness in Consumer markets. With the advent of digital technology, Esign (electronic sign) services, the need to print physical documents is less than it was 10-20 years ago.

My personal experience is that I use an HP printer for postage labels. I bought it 5 years ago. However, I find this printer to be difficult to use and prefer QR code-based postage labels. The good news for HP: the commercial business has made a strong recovery since the pandemic. Revenue from hardware recovery has increased at double digits each year.

HP+ and Big Tank printers are responsible for 55% of HP’s Print sales. The quarter saw strong 3D printing, as well as Industrial graphics, which all experienced an increase in sales year-over-year.

Profitability and Expenses

Non-GAAP operating profits of HP were $1.1 billion. This was a 15% decrease year-over-year. Non-GAAP earnings per shares were $0.85, which was down from $0.94 in previous year. However, this was still above analyst expectations of $0.01. The “Non GAAP results” exclude net expenses of $855 millions which are primarily related to one time acquisition costs, restructuring costs, and tax adjustments. Non-GAAPEPS increased by 8% for the full-year 2022 to $4.08.

The HP management has devised a number of cost-cutting strategies to streamline the business. This includes digitizing all company processes, inventory optimization and a lower fixed cost structure. The company expects to achieve $1.4 Billion in Annualized Run Rate savings by 2023 through these and other activities. This plan has been a success and OpEx spending has fallen by approximately $350 million over the past year.

The company generated strong free cash flows of $3.9 billion during the year, and returned $5.3 Billion to shareholders via stock buybacks or dividends. The company pays a healthy 3.4% dividend that has increased over the past 11 year.

The company has a strong balance sheet with $3.145billion in cash and cash equivalents, and $17m in short-term investments. HP has a high level of long-term debt at $10.8 billion. However, only $218 million is current debt.

Advanced Valuation

To value HP, I have entered the most recent financials into my advanced model of valuation that uses the discounted cashflow (“DCF”) method. I expect a conservative 5% growth in revenue for next year, and 6% growth over the next two to five years as the business’s personal computing segments recovers.

To increase the accuracy of the valuation I have capitalized R&D expenses, which has lifted the operating margin. The company’s cost-cutting efforts will result in an operating margin of at least 12%.

These factors give me a fair price of $100 per share. HP stock is 30% undervalued at $30 per share as of the time of writing.

HP trades at a forward price to earnings ratio of 8.4 which is 10% less than its 5-year average. This is a fascinating datapoint. HP trades at a lower valuation than Dell (DELL).

Risques

Recession/Cyclical Demand for PCs

Many analysts predict a recession because of the high inflation and rising interest rates. Companies that sell personal computers are in a downturn and face a difficult economic environment are not likely to prosper. Personally, I believe HP’s smaller segment Print (3% of revenue) is in a declining market. I believe physical paper is not as important as it was 10+ years ago for the reasons I mentioned (e-signatures etc.). We also have to consider the environmental impact of printing a lot of paper. The good news is that 3D printing continues to grow, so HP could keep its crown.

Final Thoughts

HP Inc. is a legacy tech company that is currently facing several short-term headwinds, including the cyclical fall in computing and unfavorable FX currency rates. The HP management is very proactive and their bold cost-cutting plays should pay dividends in the long term. Given these factors and the stock’s undervaluation I believe HP Inc. could make a great investment over the long-term.