There is no doubt that the global economic environment presents a very bleak outlook. The National Bureau of Economic Research (NBER) last week announced that the U.S. economy has been in a recession since last December – a situation that appears to be getting worse, given that the economy lost half a million jobs lost half a million jobs in November. Interestingly, the market traded up both those announcements.
On Nov. 24, Hewlett-Packard Co. (NYSE: HPQ) reported a quarterly profit of $1.03 a share, exceeding analysts’ estimates of $1.01 a share. Hewlett-Packard almost doubled its revenue from technology services from last year because of its acquisition of Electronic Data Systems Corp. earlier this year, and a 21% increase in quarterly sales of notebook computers and a 10% rise in personal computer sales.
You read that right: Hewlett-Packard recorded a big jump in three key business areas – during a recession.
These impressive results are due to Hewlett-Packard outperforming its peers with superior products and exemplary execution. What’s more, Hewlett-Packard has been an early adopter of some of the fastest chips for servers – the “Shanghai” chip by Advanced Micro Devices Inc. (AMD), which just leapfrogged the offerings of arch-rival Intel Corp. (INTC) in terms of both speed and market share.
In its core printer and server business units, Hewlett-Packard actually experienced a slight contraction in businesses.
The key to Hewlett-Packard’s better-than-expected results is the large proportion of recurring services and supplies, which are much less vulnerable to a contraction in economic activities. You need to keep your systems running with the up-to-date software and maintenance services and you need to keep buying ink for your printers. This recurrent income smoothes out earnings and is a blessing for companies like Hewlett-Packard, International Business Machines Corp. (IBM), Automatic Data Processing (ADP) and others, which benefit greatly from such sustainable income streams.
In this light, Hewlett-Packard’s management not only blew away its earnings estimates, but also came out with a much stronger-than-expected guidance. Well, the market was overbought that day and the stock sold off the next day. The word dropped by some was that the analyst community did not believe Hewlett-Packard’s rosy outlook. But the reality is that the market had anticipated Hewlett-Packard’s strong results and bid up Hewlett-Packard’s stock ahead of the announcement.
So far so good, but what about the future? Mark V. Hurd, Hewlett-Packard’s president, expects to be able to cut $1 billion in expenses in 2009 from redundancies from the EDS acquisition that he will be eliminating. And Hurd has shown a strong track record in this sense since he took the helm in 2005.
So the question is how much faster Hurd can cut costs to compensate for the reduction in economic activity, in case things keep getting worse as they very likely will in the first quarter of 2009. But there is some hope that the incoming Barack Obama Administration will add to the aggressive monetary and fiscal stimulus already approved and only partially implemented by the current administration. In any case its positive effects are only starting to be seen.
And the other question is how much downside has the market already discounted in Hewlett-Packard’s shares, which are down 38% from their 52-week high of $52.90. Well, with a trailing Price/Earnings (P/E) ratio of only 10.0 and a P/E to Growth Rate (PEG) ratio of 0.7 for this very resilient profit stream in a company characterized for flawless execution, Hewlett-Packard is a steal. This can also be said for most of the market, which is in panic state, taking refuge in government bonds yielding almost zero.
This last phenomenon has been referred to by Mohamed El Arian, co-Chief Executive Officer of PIMCO as a U.S. Treasury bubble. And in times of panic, it is a good idea to buy. So I will unequivocally recommend buying HPQ in increments. I would buy one-fifth of my position on weak days prior to year end – accumulating half our position – leaving the last half for purchase in the first quarter of 2009.
ACTION TO TAKE: BUY Hewlett-Packard Co. (NYSE: HPQ), but do so with some care. Purchase two-thirds of your position between now and year-end, and the final third during the first quarter of the New Year. **
Editor's Note: Horacio Marquez was working as a vice president of the Merrill Lynch Emerging Markets Fixed Income Group in 1994 when he correctly predicted that both Argentina and Mexico were headed for currency crises - cementing his reputation as an expert on both the emerging markets and on the nuances of global finance. Now Marquez brings that expertise to you with his newly created "Shadow Stock Trader" specialized trading service. To find out how to subscribe, please click here. "Buy, Sell or Hold" is a new Money Morning feature that has most recently analyzed such companies as Bank of America Corp. (NYSE: BAC), Suncor Energy Inc. (NYSE: SU), Potash Corp. (NYSE: POT), Garmin Ltd. (Nasdaq: GRMN), Berkshire Hathaway Inc. (NYSE: BRK.A, BRK.B), . (Nasdaq: CS), . (NYSE: CVX), Valero Energy Corp. (NYSE: VLO), General Electric Co. (NYSE: GE), and steelmaker Nucor Corp. (NYSE: NUE).]
** Special Note of Disclosure: Horacio Marquez holds no interest in Hewlett-Packard Co.
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