Shares of Hewlett-Packard (HPQ) are up 61 cents, or 2.7%, at $22.79, after Morgan Stanley’s Katy Huberty raised her rating on the shares to Overweight from Equal Weight, with a $27 price target, writing that CEO Meg Whitman has been placing an emphasis on hitting free cash flow targets that could mean upside versus what the Street thinks the company can produce in cash profits this year.
The company had projected $5 billion in free cash flow this year, back at an analyst day in October, but it’s possible they’ll hit $6.7 billion, or $3.45 per share, thinks Huberty.
The drivers of that excess are a lower deposit in a legal proceeding in India ($34 million versus $400 million), HP’s “cash conversion cycle, should end up being better than the 24 days to 26 days it projected at that October meeting, and the company may ratchet back its capital spending.
As far as cash conversion, Huberty believes the company can recoup 13 cents to 15 cents for every day less it achieves. Huberty thinks there’s actually upside from what she’s been modeling:
Even our significantly higher than consensus FCF forecast assumes a cash conversion cycle forecast of 23 days exiting FY13 and FY14, which represents limited improvement from the January quarter and HP�s history. Every one day improvement in CCC adds $0.13-0.15 of annual FCF per share and a return to historical level of 20 days (e.g. 2008) would add another $800 million, or about $0.40 per share, to FCF in FY14.
As for capital expenses, Huberty observes the rate of spending in the first fiscal quarter, ended January, indicates a lower level than the $3.5 billion in spend the company has projected, perhaps as little as ust $2 billion in “net capex” for the fiscal year.
Lastly, Huberty thinks the company can boost its profitability per employee after having already announced the slashing of 29,000 jobs, if growth improves just a little bit:
Consistent with HP�s higher OpEx metrics, the company�s EBIT per employee of $33,000 is below its peer average of $45,000. Assuming no revenue impact, the planned headcount cuts (29,000 employees) alone add $3,000 per employee, bringing HP in-line with Dell. More stable revenue streams and mix driven margin improvements could help return HP to its historical levels of $40,000 longer term. We model 40 bps of operating margin improvement in FY14 and 50 bps in FY15, which only returns HP to its FY12 operating margin of 9.3%.
Huberty’s price target implies a 7 times multiple of free cash flow, which she points out is below the 8.6 times that Dell‘s (DELL) proposed leveraged buyout at $13.65 is implying for that stock.
Tech analyst and fund manager Dan Niles of AlphaOne Capital, this morning tells me he’s also bullish on HP, which is one of the firm’s top holdings, based on share gains in the PC market, and also depreciation of the Japanese Yen.
“The first quarter you saw them gain share in PCs, that’s when it got interesting to me,” says Niles, referring to Q4 worldwide PC sales, when HP rise to 16.2% of shipments from 15.5% in the year-earlier quarter, and recaptured the crown from Lenovo (0992HK).
The company can see further benefit amidst the Dell LBO process, when Dell may be heavily distracted, points out Niles. “We’ve seen this in past, when HP said they were getting out of PCs” in the summer of 2011, and Dell immediately benefitted. “These things can turn very fast,” meaning PC market share.
Niles thinks HP is poised to benefit from a weaker Yen, as it buys toner cartridges from Canon for its printer business.
And then, too, the stock is cheap, at 6.6 times forward EPS estimates. The only word of caution Niles offers is that the PC business is still in long-term decline at the hands of tablets and smartphones, which means HP is more attractive as a stock investment while it is still deeply out of favor with most investors.
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