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Technology Stocks : Hewlett-Packard (HPQ) -- Ignore unavailable to you. Want to Upgrade?

To: Night Writer who wrote (399)	5/15/2002 2:14:28 AM
From: MechanicalMethod	Read Replies (1) \| Respond to of 4345

What's wrong with CPQ?

To: Night Writer who wrote (399)	5/15/2002 9:39:22 AM
From: Elwood P. Dowd	Read Replies (1) \| Respond to of 4345

Merrill: Buy, target price $28 by: skeptically 05/15/02 09:23 am Msg: 133344 of 133346 Comment Enterprise Hardware 15 May 2002 Steven Milunovich, CFA First Vice President Shannon Cross; Larry Tankel, CPA Hewlett-Packard Co Evidence for the Merger BUY Long Term BUY Reason for Report: Earnings Report Estimates (Oct) 2001A 2002E 2003E EPS: $0.88 $0.90 $1.35 P/E: 23.3x 22.8x 15.1x EPS Change (YoY): 2.3% 50.0% Consensus EPS: $0.89 $1.30 (First Call: 09-May-2002) Q3 EPS (Jul): $0.10 $0.21 Cash Flow/Share: $0.90 $1.78 $2.07 Price/Cash Flow: 22.8x 11.5x 9.9x Dividend Rate: $0.32 $0.32 $0.35 Dividend Yield: 1.6% 1.6% 1.7% Opinion & Financial Data Investment Opinion: C-2-2-7 Volatility Risk: Above Average Mkt. Value / Shares Outstanding (mn): $62,730.0 / 3,060 Book Value/Share (Apr-2002): $7.58 Price/Book Ratio: 2.7x ROE 2002E Average: 14.7% LT Liability % of Capital: 21.1% Est. 5 Year EPS Growth: 10.0% Next 5 Year Dividend Growth: 10.0% Stock Data 52-Week Range: $31.37-$12.50 Symbol / Exchange: HPQ / NYSE Options: Chicago Institutional Ownership-Vickers: 56.6% Brokers Covering (First Call): 9 ML Industry Weightings & Ratings** Strategy; Weighting Rel. to Mkt.: Income: Overweight (18-Jun-2001) Growth: Overweight (25-Oct-2000) Highlights: • HP’s quarter was mixed with revenue light but margins strong. The quarter provides support for the merger—HP must fix its computer losses. Compaq’s strengths in Intel servers and storage are critical. • Imaging and printing was the star and provided more than 100% of profit. Supplies now exceeds half of revenue. Although the 15.7% operating margin isn’t sustainable, HP’s range of 10-12% looks conservative. • The leaked memos regarding computer softness were mostly correct though Unix held up well. PC servers, software, and even storage bled red. Management expects little improvement in enterprise spending until next year. We’re concerned about the slowdown in the consumer business as the quarter progressed. • HP will peer into the future at its June 4 analyst meeting. Until then, we maintain our $1.35 estimate for F2003, which is based on $2+ billion in cost savings and a 7% revenue loss. • We continue to recommend the stock. We reiterate our Buy/Buy rating and expect the stock to move into the mid-to-upper $20s. Second Quarter Highlights HP reported light revenue of $10.6 billion versus our $10.9 billion estimate, but earnings of $0.25 per share exceeded our $0.24 figure. Imaging and Printing carried the day with a jump in operating margin. On the other hand, losses in Computer Systems and Personal Systems deepened, providing rationale for the merger with Compaq. HP made clear that enterprise spending is poor and unlikely to improve much in the second half and also made disconcerting remarks regarding consumer slowing. Imaging and Printing: Revenue was off 2% year over year but the operating margin jumped to 15.7%. All-in-one sales were strong and aided the mix; HP expected to see more pricing pressure here. Supplies now exceeds half of printer revenue. The margin improvement comes from mix, the weaker yen (lags by 3 months), and more supplies. HP said the margin is unsustainable given investments to be make in R&D, marketing, and plant expansion. Computing Systems: Revenue declined 20% from the prior year and the margin fell from –8% last quarter to –12.7%. Unix held up with a single-digit sequential increase and Superdome orders up by one-third. But software was down and registered a big loss while EMC’s aggressiveness heightened the storage loss. Intel servers tanked 13% sequentially with customers knowing HP’s line will be displaced by Compaq’s Proliant. IT Services: Looks like that leaked memo was right— revenue was soft at a 6% sequential decline with support off 3% and consulting down 15%. The Merrill, cont' (2) by: skeptically 05/15/02 09:24 am Msg: 133345 of 133346 Embedded and Personal Systems: Revenue fell 15% year over year and the margin dove to –4.9%. Commercial PC sales rose 4% sequentially, but consumer declined 24%. Although consumer was profitable, sales weakened as the quarter progressed and there are 8 weeks of inventory in the channel. HP took a $37 million charge for price protection. Higher memory costs added $35 per unit. Tight cost and expense control compensated for lower revenue. The gross margin improved from 26.9% in F1Q to a strong 28.7%. The printer business hitting on all cylinders was the main factor. Expenses were up just 1% sequentially. Other income was reduced by $40 million ($0.02) for write-offs relating to Argentina. There was a non-operating $260 million charge, including $140 million for proxy solicitation and advertising to get the deal done. The balance sheet was impressive with $2.1 million in operating cash flow generated; free cash flow was $1.7 billion. Receivable days were flat at a low 33 while inventory turns rose to 7.9X from 7.3X. HP has $9.4 in cash, which rises to more than $13 billion with Compaq. Outlook: The Work Begins HP did not provide any outlook for the combined company, choosing to wait until the June 4 analyst meeting in Boston. We forecast $1.35 for HPQ in F2003 assuming $2+ billion in cost savings and a 7% revenue loss. Here are some thoughts on the outlook: - HP’s earnings highlight the importance of merging with Compaq. HP has to fix its bleeding computer businesses; Compaq is critical to narrowing losses in Intel servers and in storage. HPQ is the PC channel now, which provides leverage. Software remains a glaring problem, though. President Michael Capellas argued at Hardware Heaven that OpenView can be turned into a data center automation product and that middleware quickly will commoditize. - The revenue shortfall could cause concern regarding HP’s assumption of a 5% revenue loss. CFO Bob Wayman knew F3Q's revenue when he suggested that HPQ might lose even less than 5%. The Unix business was a prime suspect to suffer from merger distractions but it didn’t. - Investors were impressed by AMAT’s orders, but HP sees little improvement in enterprise spending until 2003. Growth could improve to 2% in the second half, but 8-10% gains won’t kick in until next year. - Although the printer operating margin of 15.7% isn’t sustainable, HP’s suggested range of 10-12% looks conservative. With supplies now over half of imaging revenue and a low-cost head architecture coming by F4Q, a 13% margin looks more reasonable. A stronger yen (and higher print engine cost) is a risk that could negatively impact F4Q profit. - Consumer PC margins could be under pressure in F3Q. The consumer PC inventory build-up in the channel means a production slowdown and underabsorbed overhead while HP said it would price aggressively to maintain share while it’s vulnerable. - We expect that most of the computing sales management will come from the Compaq side. HP has had consistent go-to-market problems the past few years. - HP plans to sell less expensive ink cartridges with the lower price mostly due to less ink. That is, users should find lower cartridge prices but more frequent visits to the store. HP hopes to make even higher margins. Although there are puts and takes along with substantial integration risks, we think our support of the deal will be rewarded. Cost savings and a more powerful vendor should result in a trade to at least the mid-$20s; our sum-of- the-parts analysis comes up with $28 per share. And if there’s ever a PC upgrade cycle, investors should consider buying HPQ at 15X versus Dell at 35X and Intel at 30X.