Goldman Sachs issued a target price of $16 on Hewlett-Packard's (NYSE:HPQ) stock April 2. At the same time it cut its rating on the stock to "Sell," sending the stock for a 6% drop in intraday trading. The obvious question is whether investors should jump ship. Here are my two cents on the matter.
Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.
When the Hewlett-Packard CEO took the helm at eBay (Nasdaq:EBAY) in February 1998, the e-commerce company wasn't even publicly traded yet. Whitman took it public September 24, 1998, at $18 per share. By the time she announced her retirement January 23, 2008, its stock had grown significantly. eBay shareholders got very rich during the CEO's reign as did Whitman whom Forbes suggests is worth $1.9 billion. It was that pedigree which brought HP to hire her in September 2011. In the job 18 months now, is it enough to keep her there?
While Goldman cut its HP rating, it did admit the company did a good job generating $2.6 billion in cash flow in the first quarter, up 115% year-over-year. But that's about as generous as it was willing to get suggesting HP's turnaround was only in the very early stages and much work was necessary for them to contemplate a change from its $16 price target, 28% lower than its April 2 closing price.
HP's stock is up 56% year-to-date thanks to Whitman winning over the investment community with 29,000 in job cuts over two years that will make it a more competitive business. Investors also are dreaming about the development of a service business much like IBM's (NYSE:IBM) with high-value industry-specific consulting practices generating significant revenue and profits. So far, the service side of the business seems to be going in the wrong direction. After taking into account the realignment of segments at the end of fiscal 2012 in October, its enterprise services group saw revenues and non-GAAP operating profits decline 7% and 48% year-over-year respectively. With the exception of HP Financial Services and Printing, all of its segments saw declines in both revenues and operating profits. If a 6% decline in overall revenue combined with a 13% decline in operating profits is the way to salvation I'd rather not be rescued.
In its financial presentation of Q1 results, HP provides a very grim picture demonstrating how much faith investors are putting in Whitman's leadership capabilities. Its $28.4 billion in revenue is the worst first quarter in the past four years as is its non-GAAP diluted earnings per share. I know it has new products coming down the pipe including the second generation Moonshot server but with half its business dedicated to products dying a slow death, one can't help but wonder if Whitman's efforts will be a day late and a dollar short.
SEE: 5 Must-Have Metrics For Value Investors
However you feel the turnaround is going, the simple fact remains that there are better alternatives in the tech sector. Although HP has reduced its operating company net debt from $11.8 billion in Q12012 to $4.7 billion in Q12013, Barron's points out that Microsoft (Nasdaq:MSFT) has $7 a share in net cash, is in much better shape as a business, and trades at only a slightly higher multiple. With 56% gains already in the bag and no sign that the turnaround is moving very fast, you have to consider the downside risk here is too great. Especially if it has any unexpected bad news after announcing better than expected Q2 guidance in February.
SEE: Earning Forcasts: A Primer
Investors barely voted in three of the 11 board members at the annual meeting in March, giving Chairman Ray Lane and two others a good scare. Last year all three got more than 80% favorable votes; this year all three were below 60%. The natives are restless and this was shareholders' warning shot across the bow. One more screw up and you can be sure that someone will be made to walk the plank.
Meg Whitman comes with a great pedigree so you can be sure that the board won't doing anything rash. As long as she keeps inching the company forward, it doesn't make sense to fire another CEO. However, inching forward and being a good business are two entirely different animals. Goldman Sachs is right. HP's stock will fall back close to where it began the year within the next 6-12 months.
At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.