$HPQ Fiscal Q4 Earnings Preview

by Enis November 25, 2013 8:08 am • Commentary

Event:  HPQ reports its fiscal Q4 earnings on Tuesday after the close.  The options market is implying about a 7.5% one day move, which is much lower than the 4 qtr avg of about 13.5% and still lower than the 8 qtr avg of about 9%.  HPQ management gave positive 2014 guidance on its analyst day call in early October, which has taken away some of the uncertainty heading into this quarter’s earnings results.

Sentiment:  Wall Street analysts are negative on the stock, with 8 buys, 22 holds, and 5 sells, with the average 12 month price target right around the current price, just above $25.  Short interest has declined to a 1 year low, around 2.3% of float, from over 5% of the float a year ago.  The stock is up 77% so far in 2013.

Options Open Interest:  In overall open interest, puts favor calls by a ratio of 1.1 to 1, despite the strong rally in 2013.  1 month average volume has been skewed to calls, however, by a ratio of 1.4 to 1.  The Dec 25 calls has the most open interest among short-term maturities, at almost 18k.  Jan14 open interest is more pronounced, with over 40k of open interest for the 25 calls, and over 30k of open interest for the 25 puts.  The Jan15 17 puts have over 25k of open interest, the most among farther-dated maturities.

Price Action / Technicals:   HPQ’s monster gains took place mostly in the first 3 months of the year (when the stock rose from $14 to $24).  Since then, the stock has made some big moves back and forth, but basically between $20 and $28 the entire time:

HPQ daily, Courtesy of Bloomberg
HPQ daily, Courtesy of Bloomberg

The stock chart looks less impressive if we zoom out to the weekly view.  The stock is essentially unchanged over the last 2 years, though it was quite a decline and then ascent in that period:

HPQ weekly chart, Courtesy of Bloomberg
HPQ weekly chart, Courtesy of Bloomberg

HPQ is down 50% from its early 2010 high.  In short, there is still a significant amount of upside resistance from long-term trapped owners of the stock.

Fundamentals/Valuation:  The key question that has separated HPQ bulls from bears over the past 6 months is whether the restructuring / cost cutting will eventually lead to higher earnings and cash flow, or is simply starving an organization that is already suffering from years of underinvestment.

HPQ’s expected revenues of $110 billion in 2013 is down more than 10% from the 2010 and 2011 sales peak.  Revenues are expected to continue to decline in 2014 ($107 billion) and 2015 ($106 billion), but earnings are expected to rise on lower costs ($3.64 and $3.70 are the respective EPS estimates).

The current quarter is expected to be decent.  CEO Meg Whitman also expressed optimism for 2014 and 2015 due to lower costs and an improved product mix in an analyst call in early October.  That news sent the stock 10% higher from near $20, and the stock has marched higher ever since.

While Personal PCs are expected to have had a decent quarter on market share gains by HPQ, the real risk lies in the Enterprise division.  Enterprise hardware and services make up almost 50% of revenues, and IBM and CSCO both reported dismal quarters due to weak enterprise demand.

At almost 10x GAAP EPS, HPQ’s P/E multiple is no longer the bargain it was to start 2013.  With little earnings growth expected year over year, the stock is more a bet on growing earnings than on an expanding multiple.

Volatility:  Implied volatility in HPQ is lower than it has been ahead of earnings over the past year:

30 day implied volatility (red) vs. 30 day realized volatility (blue) in HPQ, Courtesy of LiveVolPro
30 day implied volatility (red) vs. 30 day realized volatility (blue) in HPQ, Courtesy of LiveVolPro

That low level of implied vol today is partly due to the positive comments from management in early October about 2014 guidance.  That has taken some of the surprise element out of the earnings report, though 6 weeks have passed since that update.

Our View:  HPQ is one of the best performing hardware stocks of 2013.  That strong outperformance is largely a function of dismal performance in 2010, 2011, and 2012.  With the stock’s P/E close to 10, combined with the secular headwinds that the company faces, a range bound situation between $20 and $28 over the next 3-6 months seems the most likely outcome.

In the long run, the stock’s direction depends on whether the restructuring has permanently hurt the company’s long-term earnings run rate.  With the company more focused on financial re-invention rather than technology invention, the answer to that question seems more likely than not to be Yes.