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Tech stocks are in crash mode. The NASDAQ is down nearly 5% over the last month. Investors are trading in growth tech companies for value names. But as tech investors make that transition, they’re also turning to turnaround stories.
Some of the names that investors have been rallying behind are IBM (NYSE: IBM), Microsoft (NASDAQ: MSFT) and Intel (NASDAQ: INTC). All of these stocks are up over the last month.
HP: The Top Turnaround Stock
But the name that’s up the most is Hewlett-Packard (NYSE: HPQ). HP’s stock is up 14% year to date, versus a NASDAQ Composite that’s down 2%. Are investors finally listening to the HP’s turnaround story?
It appears so. But shares of HP are still down nearly 40% over the last four years. And HP is very cheap from a valuation standpoint.
It’s a cheap stock that generates stacks of cash every quarter. Last quarter it added $4 billion to its cash hoard. Leading to a near 30% boost in its cash pile from the previous quarter.
Many investors see the declining PC industry as an overhang. Hence the reason HP still trades at a hefty discount, compared to some of its major tech turnaround peers.
But the fact that the PC market is in decline is no secret. So what’s the market missing?
Hewlett-Packard has already gotten a nice boost in its stock price thanks to the growth of PC shipments during the first quarter of this year. The stock’s now trading close to their 52-week highs.
It’s not unreasonable to believe that the decline in PCs will eventually plateau. The penetration of tablets is already at 50%, where half of all U.S. households own a tablet. At some point, spending could shift back toward PCs as homes look to upgrade their current devices.
And the decline in PCs has been slowed by Microsoft ending its support of the XP operating system. As a result, businesses are replacing their old PCs with new ones.
Europe, the Middle East and Africa are also seeing growth in PC sales. The penetration rate of PCs in these countries remains below developed nations. And after eight quarters of PC sales declines, sales in EMEA grew during the first quarter of 2014. HP is the market share leader in this region, owning 19.9% of the market.
And HP is finding ways to hedge the decline in PC sales. Although HP’s sales of notebooks and desktops have fallen 20% over the last two years, total revenues have only fallen 11.5% over that time period.
That’s because the server market remains one of the key places that HP can make up the decline in PC sales. At the end of 2013, HP owned 28% of the server market. It overtook IBM, with IBM’s market share was down to 26.5% at the end of 2012, versus 34.9% in 2012.
And an increase in information technology and infrastructure spending by businesses would be a positive a big positive for HP and the server market. This comes as more companies are making the shift to the cloud. Then there’s other opportunities for this turnaround stock, including the potential to enter the 3D printing market.
Despite the massive cuts that it’s made to its workforce, HP still has room for additional cost cutting. Its net margin is in the low single-digits, which is below the high-single digit margin that HP saw a few years ago.
With all that said, is HP a turnaround stock worth owning? Where else are you going to find a company that’s a market share leader and trading at a P/E of only 8.5 based on next year’s earnings?
Even a couple other “old” tech companies trade at a premium to HP. Xerox (NYSE: XRX) has a P/E of 9.4 based on next year’s earnings estimates and Lexmark (NYSE: LXK) is at 11.7. Yet, HP has a return on equity that’s above both these companies.
But do we really need HP’s P/E to rise to make the company a sound investment?
Cash is the real reason investors should take a look at this turnaround stock.
HP is nothing short of a cash flow generating machine. Its free cash flow yield is 13%. Compare that to Apple (NASDAQ: AAPL), which has a free cash flow yield of 7%.
HP has amassed enough cash to cover over 25% of its market cap. And the fact that it is committed to returning over 50% of free cash flow to shareholders should income seeking investors.
HP’s dividend yield is at 1.8%. Although that dividend yield is the same as the S&P 500, it’s only a 20% payout of the company’s earnings. There’s plenty of room for HP to increase its dividend yield. Then there’s also share buybacks.
Last year the company generated $4.30 in free cash flow per share. With HP’s commitment to return 50% of free cash to shareholders, that means $2.15 a share is for investors (either via dividends or buybacks). That kind of return for shareholders represents a 6.6% total annual yield. And doesn’t account for any appreciation in the stock price.
Turnaround stock or not, that kind of total yield isn’t all that bad for a company that has enough cash to cover its debt, and trades at a 40% discount to the S&P 500 on a P/E basis.
The One Stock to Own in 2014 — The Year Mobile Takes Over
On Dec. 31, something incredible happened. For the first time in history, the majority of Internet traffic originated from NOT from PCs or desktops — but from mobile devices including smartphones and tablets. We’re never going back. Mobile is taking over. And even though the biggest player in mobile, Apple, is selling over 200 million iPhones this year alone… here at Wyatt Research, we’re recommending the one company no one is taking about. The one reaping massive profits each time a new Apple or Samsung smartphone is activated. In fact, as mobile data usage explodes in the year ahead, its stock is set to soar! Shares are already on the move. So, before this stock moves any higher, read our latest report for all the details: Click here for the full story.