The Broader Market Is Due For A Pullback And So Is HPQ!
** Buy the HPQ May 2013 16.000 put (HPQ130518P00016000) at or under $1.00, good for the day. Place a protective stop limit at $0.40 and a pre-determined sell at $2.00.
by Ian Harvey
February 06, 2013
Key measures of investor sentiment and market performance have reached extreme levels, indicating that the odds of a short-term downturn are rising. In the last couple of weeks, Bespoke Investment reported the following information on its blog:
• The American Association of Individual Investors (AAII) weekly sentiment survey is showing bullishness among individual investors at a two-year high.
• On Wednesday, last week, 79.6% of U.S. stocks were in overbought status (as calculated by Bespoke) — the highest since March 2007.
• Over 90% of S&P 500 stocks were trading over their 50-day moving averages, only the sixth time this has occurred since 2009.
If these extremes do in fact result in a pullback, the type of lower-quality tech stocks that have come so far in recent weeks are almost certain to underperform.
Previously any tech stock could make money -- even Pitney Bowes (NYSE:PBI) is up 11% in the past two months.
But it’s now time to start looking for opportunities to bet the other way, and Hewlett-Packard (NYSE: HPQ) appears to be one of the best options on this front.
For Hewlett-Packard Company, the end of 2012 could not come soon enough. The company’s revenues and earnings were down. Its main business, personal computers (PC’s) and printers, is in decline. The stock price is reflective of the company's poor performance and is down by almost 50% for the year.
About Hewlett-Packard Company
Hewlett-Packard Company is a provider of products, technologies, software, solutions and services to individual consumers, small- and medium-sized businesses (SMBs) and large enterprises, including customers in the Government, health and education sectors.
Its operations are organized into seven segments: the Personal Systems Group (PSG), Services, the Imaging and Printing Group (IPG), Enterprise Servers, Storage and Networking (ESSN), HP Software, HP Financial Services (HPFS) and Corporate Investments. In March 2012, HP had consolidated PSG and IPG into a Printing and Personal Systems Group. HP continues to report the results of IPG and PSG separately.
HP’s offerings include personal computing and other access devices; multi-vendor customer services, including infrastructure technology and business process outsourcing, application development and support services, and imaging and printing-related products and services. In December 2011, the Company acquired Hiflex Software GmbH.
During the rally of the past two months, few areas of the market have generated outperformance like last year’s tech-sector laggards. Almost across the board, the most troubled stocks of 2012 have seen their returns goosed by company-specific news and/or investors’ effort to capitalize on their low valuations.
The numbers speak for themselves:
|Company||TICKER||RETURN, 11/15/12 – 1/25/13|
|Research in Motion||RIMM||99.4%|
|Advanced Micro Devices||AMD||52.4%|
|Technology Select Sector SPDR||XLK||6.7%|
The Rationale Behind the Pullback
There are several problems facing HPQ:-
1. The biggest problem that HPQ has is that it is at the wrong end of the computing business. Desktop computers and even laptop computers are now considered old school, while tablets and smartphones are all the rage. There is still money to be made in the computer business, but the money is being made by companies that provide cloud based computing solutions. Companies like Apple Inc. (NASDAQ:AAPL) and Samsung have seen both their earnings and their stock prices flourish – although Apple is suffering at the moment. Old school computer companies like Hewlett-Packard Company (NYSE:HPQ), Dell Inc. (NASDAQ:DELL), Intel Corporation (NASDAQ:INTC) and Microsoft Corporation (NASDAQ:MSFT) have fallen behind, and their stock prices are near 52-week lows.
2. On top of all this competition in the hot tablet space, a recent report by the World Economic Forum highlights the core problem for HP. It predicted that in 2012 PC sales will decline for the first time in 11 years. There are a myriad of reasons for the decline in PC sales. Weak macro-economic conditions, cannibalization from tablets and smartphones, elongation of replacement cycles and the final straw is full penetration in emerging markets. Analysts at IDC and Gartner said PC shipments in this year’s third quarter were down by 87.5 million, or 8% lower than a year ago. What is particularly troubling for HP is that the decline in PC sales will be an ongoing trend. Todd Bradley, the head of Hewlett-Packard’s PC business, said he thinks the core PC market will stay flat “potentially through 2015.”
3. The company has had too many changes in management and too many horrible acquisitions. After so much confusion and so many missteps it will take quite a while to turn the company around. The purchase of EDS and Compaq were terrible mistakes, but the 2011 purchase of Autonomy for $11.1 billion was devastating. The purchase did not help the value of HP’s portfolio and HP has written off $5 billion of Autonomy’s value. In addition on November 21 HP confirmed that the U.S. Department of Justice was investigating Autonomy’s books. Over the last 10 years HP has spent $67 billion acquiring companies and its current market cap is less than $27 billion. These mistakes have hurt HP badly. They have caused the company to take on excess debt ($28.4 billion) and will hamper its ability to restructure itself as it moves forward.
4. Also CEO of HPQ, Meg Whitman, has said “Make no mistake about it; we're still in the early stages of a turnaround.” HP plans to transform its business from being a PC maker to providing software services, cloud computing services and possibly even providing mobile devices. Unfortunately for HP, it has formidable competitors that are way ahead of it in these businesses. In the software services business it must compete against giants like Microsoft, International Business Machines Corp. (NYSE:IBM) and Oracle Corporation (NASDAQ:ORCL). In the cloud computing service business it will compete against Amazon.com, Inc. (NASDAQ:AMZN) “Web Services,” Rackspace Hosting, Inc. (NYSE:RAX) and salesforce.com, inc. (NYSE:CRM). Finally, in the mobile device business it would be forced to compete against Apple and Samsung. I do not doubt HP’s CEO’s Meg Whitman’s good intent, but HP will have a hard time catching up with any of these companies.
5. Another bit of bad news for HP came when the company accused two former employees in Austin, Texas, of conspiring to resign simultaneously and recruit 16 colleagues in their information technology department to take jobs with General Motors Company (NYSE:GM). It now seems that HP’s announcement of 29,000 job cuts by 2014 has caused tension between management and rank and file employees. Adding to the problem is that in October GM announced that it would hire 3,000 of HP’s IT employees. Losing valued employees during a period of transition could be a big problem for HP. HP has filed a lawsuit with a Texas court saying that “former IT directors Gregg Hansen and Todd MacKenzie had led a "seemingly orchestrated departure" to GM in an abrupt move November 30.” When employees revolt against their employer that is certainly a bad sign.
6. The ongoing turbulence in its business operations has forced HPQ to opt for major restructuring activities. Recently, H-P announced its decision to reorganize its Enterprise Services business by way of shutting down its German unit. The unit is situated at Rüsselsheim and employs about 10,000 employees.
The closure is likely to eliminate 850 positions. The company also announced plans to transfer another 250 employees to its partner companies or clients.
This announcement is a part of its global restructuring plan chalked out in May 2012. Per the plan, which was made to achieve some long term benefits, H-P will focus on reducing the cost structure and realigning the workforce to create investment capacity, support growth initiatives and innovation and enable more effective operations globally.
As part of the restructuring, H-P also expected to announce 9,000 job cuts in fiscal 2012 and cumulatively, approximately 27,000 employees by the end of fiscal 2014.
H-P expects the restructuring actions to generate annualized savings in the range of $3 billion to $3.5 billion exiting fiscal 2014. The refocus of the business involves investment in technology and business processes, as well as the hiring of people with new skill sets, in some cases, at lower-cost locations. On top of the cost savings from headcount reductions, the company expects further non-labor savings from supply chain efficiencies and a new price and promotion strategy.
Though the restructuring is encouraging, the benefits may not be felt in the near term.
In the last six months institutional investors have sold more than 88 million shares of HP, reducing institutional ownership by 6.29%. While this is bad news for investors, the stock is still trading at a P/E of 4.35x, which is way below the industry P/E of 18x.
HPQ stock has a “Hold” rating by Zacks -- but the stock has an earnings Expected Surprise Prediction or ESP of -2.8%, which lowers the chances of an earnings beat in its first quarter 2013 earnings announcement on Feb 21.
Jefferies has set its price target on shares of HPQ at $10 per share and rated the stock as Underperform. The company’s stock began climbing Wednesday, last week, amidst speculation about the divestures, but has started a downturn again!
TheStreet Ratings rates Hewlett-Packard as a sell. The company's weaknesses can be seen in multiple areas, such as its deteriorating net income, generally high debt management risk, disappointing return on equity, poor profit margins and generally disappointing historical performance in the stock itself.
It is now official that HP stock will be the worst performer of any stock in the DOW Jones 30. The stock is down by 48% on the year. The stock has rallied by nearly 22% since it hit its low on November 20, but I doubt that it will move much higher. HP will have to go through a long restructuring process and Meg Whitman has warned that for HP Fiscal year 2013 will be a "fix and rebuild" year. She also went on to tell the investors “real recovery and expansion at HP” would not happen until 2014. Some investors will be tempted to buy into HP because the stock is cheap (Forward PE ratio 3.95/price to book ratio 1.2).
I think that HP will eventually reinvent itself and become profitable. However, I predict that matters will get worse for HP before they get better.
Therefore, based on the facts above the following options trade is recommended…..
**OPTION TRADE: Buy the HPQ May 2013 16.000 put (HPQ130518P00016000) at or under $1.00, good for the day. Place a protective stop limit at $0.40 and a pre-determined sell at $2.00.