Name That Trade $HPQ – Whitman Sampler

by Enis July 10, 2013 2:17 pm • Commentary

HPQ stock has had quite the turnaround.  Ever since its capitulation low in November, the stock has more than doubled, and is up more than 75% so far in 2013.

The stock’s bottom and subsequent rise shows that value-players finally became interested in the stock’s risk/reward below $20, after HPQ fell all the way from $54.75 in 2010.  The company is still expected to earn $3.50-$3.75 in adjusted EPS in the next 3 years.

Moreover, HPQ management has done a good job in its restructuring, drastically improving the company’s cash flow position.  The real risk, though, is that all the cost cutting has permanently impaired the future earnings power of the company.  HPQ should arguably be investing more, not less, than its technology competitors since its business focus is still within so many of the areas of technology in secular decline (printing, desktops, etc.).

The technical picture shows the stock attempting a new breakout above its June high at $25.87:

1 year daily chart of HPQ, with 50 day ma in pink and 200 day ma in black, daily volume in lower panel.  Courtesy of Bloomberg
1 year daily chart of HPQ, with 50 day ma in pink and 200 day ma in black, daily volume in lower panel. Courtesy of Bloomberg

Since the stock’s capitulation in bottom (volume bar circled in green), the stock has generally seen much stronger volume on the upside than on sell-offs, including the earnings breakouts in February and the breakout in May.  In contrast, today’s breakout is on relatively light volume, and is struggling to hold above the prior high.  Though not shown on the graph, this would be the weakest breakout from a momentum perspective (on the RSI) so far this year.

Add that uninspiring technical picture to a challenged fundamental backdrop without a compelling valuation story anymore, and you can see why we don’t like HPQ here.

In sum, while management has done an admirable job cutting costs, that likely has come at the expense of future growth.  Moreover, given the stock’s rally so far this year, the valuation discount that was appealing as a cash flow story no longer holds the same attractiveness.  Analysts project around $3.50-$3.75 of annual earnings over the next 2 years, and a 8-10x P/E multiple would put the stock around 30-35 in 2 years.  That’s the optimistic scenario though, particularly since HPQ is in the worst end markets of the technology sector.

We considered selling the August 25/27 call spread around 1.10 to open, but want to see if the breakout actually sticks or not.  Another structure we considered was buying August / September put calendars, since HPQ earnings are not until after August, and earnings has been the big driver of volatility for the stock this year.  Doing nothing for now though.