On Wednesday, Hewlett-Packard (NYSE: HPQ ) executives got a chance to make their case to the analyst community after a rough two months. Since mid-August, Hewlett-Packard has offered a downbeat view on the 2014 revenue environment, shaken up its leadership team, and been booted from the Dow. None of these developments has been good for HP investors.
Fortunately, rumors of HP's demise have been greatly exaggerated. Management's message on Wednesday was clear: While HP is not yet a healthy business, it is definitely improving. The highlight of the day was HP's FY14 outlook. The company expects the pace of its revenue decline to moderate, with patches of growth. Moreover, EPS will be up year over year. Lastly, Hewlett-Packard plans to reward shareholders for their patience with higher share buybacks next year.
Earlier this week, I offered a preview of the HP securities analyst meeting and argued that it was critical for HP to forecast a return to earnings growth, even if it was only modest growth. On Wednesday, HP did just that. The company expects FY14 non-GAAP EPS of $3.55-$3.75.
At the midpoint, that represents 3% growth over the expected FY13 total of $3.56. It is also roughly in line with the average analyst estimate for FY14 EPS of $3.63. This will lead to solid FY14 free cash flow of $6.0 billion-$6.5 billion, despite $1 billion in cash restructuring costs.
Open the spigot
As most investors hoped, HP's solid financial outlook and improved balance sheet will allow it to return more cash to shareholders next year. Whereas Hewlett-Packard has used more than 75% of its free cash flow in FY13 for repairing its balance sheet (paying down debt and adding to its cash stockpile), it plans to return at least 50% of its free cash flow to shareholders next year.
Moreover, according to CFO Cathie Lesjak's presentation, the company has a "bias toward share repurchases" over bigger dividend increases. Since HP is currently paying about $1.1 billion annually in dividends, its forecast implies that it will probably spend at least $2 billion on buybacks in FY14.
The focus on buybacks over dividends suggests that HP's management team and board believe that the stock is still undervalued. Hewlett-Packard's buyback plans for FY14 could reduce the share count by around 5% if the stock price remains near recent levels, which would produce a corresponding benefit to earnings per share.
Turnaround on track
Based on the outlook Hewlett-Packard offered on Wednesday, I continue to believe that the stock is undervalued. HP is set to return to EPS growth next year. This growth is likely to accelerate in FY15, when HP's restructuring will be complete and its recent investments will start to pay off in a meaningful way. Yet the stock still trades for a little more than six times earnings.
Under CEO Meg Whitman, HP is aggressively pivoting away from consumer markets, where the company is unlikely to grow profitably, and toward enterprise technology markets, where HP has a bigger competitive advantage. The company still faces risks, but these are easily offset by HP's bargain valuation. As a result, I think the stock has at least 50% upside over the next two to three years.
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