Hewlett-Packard (HPQ; recent price, 43) is a top-tier maker of computer hardware and printers that is growing by acquisition in services and software to become an even larger provider of information technology solutions. We believe that the advantages of larger scale and better balance between complementary hardware, software, and services segments include attracting customers seeking one-stop shopping, more recurring and stable revenue streams, better global market coverage, and, not least, a big opportunity to enhance profitability by cutting operational costs.
The company recently undertook an ambitious acquisition of Electronic Data Systems (EDS), which we believe offers HP the opportunity not only to beef up the services component of its three-segment strategy but also to create value through reorganization and cost-cutting on a large scale. In our view, the management team under Mark Hurd, CEO since Apr. 1, 2005, has demonstrated its ability to improve profitability by focusing on costs. For instance, HP's return on equity went from about 6.4% in fiscal 2005 (October), to about 19.0% in fiscal 2007. Although restructuring charges may blur the GAAP-based earnings and margin picture for about two years, we expect EPS improvement on an ex-charges basis and believe the company will emerge as a stronger organization after EDS is fully integrated.
We view HP shares as very attractively valued, at a recent price-earnings ratio of 11.6 times, based on our calendar 2008 EPS estimate of $3.72. This is toward the low end of a five-year historical range for HP's p-e ratio, and well below an average p-e of about 20.9 times. The valuation for HP is also at discount to a recent p-e level of 16.7 times for companies in the S&P 500 Information Technology Sector based on S&P estimates for 2008 earnings. Our target price of 61 assumes multiple expansion based on our view of solid revenue and earnings growth and successful integration of EDS.
The stock carries Standard & Poor's highest investment recommendation of 5 STARS (strong buy).
COMPANY PROFILE
Founded in 1939 and based in Palo Alto, Calif., Hewlett-Packard is an information technology company doing business in over 170 countries worldwide. The company is among the largest IT companies, with fiscal 2007 revenues of $104 billion that we estimate will grow organically and by acquisition to $119 billion for fiscal 2008, and to about $146 billion in fiscal 2009. More than most other IT companies, HP derives its sales from overseas, with two-thirds of fiscal 2007 sales coming from outside the U.S. This international presence reduces single country market risk, in our view. The company had 172,000 employees at the end of fiscal 2007.
The company is a top competitor in several key IT markets. It holds a leading market share of about 18.9% in personal computers, based on worldwide PC unit shipments in the second quarter of 2008, as tallied by market research firm IDC. It competes with rivals Dell (DELL) (16.4% second-quarter 2008 market share), Acer (9.5%), Lenovo (7.9%), Toshiba (4.5%), and Apple (AAPL) (3.5%) in the PC arena. The PC market is a large one, with global sales near $261 billion in 2007 and estimated near $286 billion for 2008 by IDC.