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Robert Abbott
Robert Abbott
Articles (811)  | Author's Website |

Good News on the Dividend Front From HP Inc.

Behind its current high-yield status is a company with reasonable fundamentals

July 02, 2020 | About:

Scanning the headlines about HP Inc. (NYSE:HPQ), formerly Hewlett Packard, generates quite a range of good and bad news.

But what kind of a dividend stock is it? Based on its inclusion on the High-Yield Dividend Screener & High-Dividend Yield Stocks in Guru's Portfolios list, it must have some merits. To get onto that list, a stock must be held by at least one investing guru, and it must offer a dividend yield of at least 4%.

We’ll look at the dividend specifics in a moment, but first, what is this company that has been through a significant transition in the past decades?

It was the Hewlett Packard Co., one of the pioneers in the development of personal computers and peripherals, especially printers. In 2015, the company was split into two publicly-traded entities:

  • HP Inc. took the computing and printing divisions.
  • Hewlett Packard Enterprise (NYSE:HPE), which took the enterprise product and business services divisions.

HP Inc. also received the company’s original ticker and stock market history prior to 2015.

It describes itself, in its 10-K for 2019, this way: “We are a leading global provider of personal computing and other access devices, imaging and printing products, and related technologies, solutions and services. We sell to individual consumers, small- and medium-sized businesses (“SMBs”) and large enterprises, including customers in the government, health and education sectors.”

Not surprisingly, its revenue fell and then recovered somewhat after the enterprise division was spun off. Earnings per share stayed about the same since 2015:

GuruFocus HP Inc. revenue and earnings per share chart

One of the important consequences of the spinoff was to deleverage HP:

GuruFocus HP Inc. deleverage chartOverall, the company gets moderate ratings from the GuruFocus system:

  • Financial strength: 5 out of 10
  • Profitability: 7 out of 10
  • Valuation: 5 out of 10

There are a couple of important points to be taken from its financial strength summary:

GuruFocus HP Inc. financial strength

First, it has a strong Interest Coverage rating, indicating its operating income is producing enough cash to pay its interest expenses many times over.

Second, it has a high return on invested capital versus weighted average cost of capital rating. ROIC is 25.7%, while WACC is 5.3%. That means for every dollar of capital, whether equity or debt, the company can earn roughly 5 times as much as the capital costs.

More worrisome is HP’s operating margin, which is found on the profitability table. It is now at 7.3% and GuruFocus notes, “HP Inc operating margin has been in 5-year decline. The average rate of decline per year is -2.3%.”

Turning to the dividend, we will analyze it by assessing each of the lines in the Dividend & Buy Back table of HP’s summary page:

GuruFocus HP Inc. dividend table

Dividend yield

At midday on July 2, the yield had slipped just below the 4% mark. If it stays below, it will be removed from the high dividend lists.

And while it is high enough to beat most of its industry peers (green bar), it is substandard based on its previous history, as indicated by the reddish bar.

This 10-year chart shows the current strength of HP Inc.’s yield is at least partially the result of a decline in the share price:

GuruFocus HP Inc. dividend yield and share price chart

Getting back to the main point, if the company’s share price increases just a bit, it could be pushed off the high dividend list.

Dividend payout ratio

The ratio is 33% of earnings, a relatively low number. It means the company is retaining 66% of earnings to reinvest in the maintenance of its existing business and to develop new business.

As a technology company, HP needs research and development; as it noted in the 10-K, “Innovation across products, services, business models and processes is a key element of our culture. Our development efforts are focused on designing and developing products, services and solutions that anticipate customers’ changing needs and desires, and emerging technological trends.”

It has been growing its research and development budget, again according to information in the 10-K:

  • 2017: $1.19 billion or 2.3% of net revenue.
  • 2018: $1.40 billion or 2.4% of net revenue.
  • 2019: $1.50 billion or 2.6% of net revenue.

Three-year dividend growth rate

Above, I noted that the increase in the dividend in yield was partly driven by a lower share price. But we learn from the dividend growth rate line that HP has increased its dividend rate by an average of 8.9% per year over the past three years.

Does it have the free cash flow strength to keep increasing the dividend, and at this rate? This three-year chart shows that perhaps it could keep raising its dividend, assuming free cash flow remains steady or grows:

GuruFocus HP Inc. free cash flow chart

Forward yield

At 4.08%, the forward yield is slightly higher than the trailing 12-month yield, suggesting HP raised the dividend in the most recent quarter. And that turns out to be the case, with a dividend payment of 17.62 cents, as reported in the second-quarter earnings release.

In 2019, it paid dividends of 64 cents, annualized. That works out to 16 cents per quarter and makes the new rate almost 2 cents higher.

Five-year yield-on-cost

The yield-on-cost is 3.92%, indicating this is what investors would receive if they bought and held the stock for the next five years, while the company grew its dividend at the same rate as during the past five years.

Because that’s less than the current yield of 3.98%, it implies the company will not increase its dividends in the next five years, which appears dubious based on what we already know.

Share buybacks

The present buyback ratio is 5.2, which indicates the company has been ambitiously buying back its own stock.

That continued in the second quarter of this year, with the company reporting: “HP also utilized $0.1 billion of cash during the quarter to repurchase approximately 5.6 million shares of common stock in the open market.”

As this chart of shares outstanding over the past five years indicates, the company has been actively reducing the share count:

GuruFocus HP Inc. shares outstanding chart

Share buybacks and dividends both contribute to a company’s total return on investment.

Valuation

On the issue of valuation, GuruFocus gives HP a 5 out of 10.

Checking the price-earnings ratio, we see it is 8.45, well below the market’s belief that 15 is the generic dividing line between underpriced and overpriced. And at its highest, in 2017, the price-earnings ratio was hitting around 16.

GuruFocus HP Inc PE ratio chart

While we normally would be cautious about a discounted cash flow calculation for a company with only one-star predictability, the DCF does line up with the price-earnings ratio, giving it more credence. According to the DCF calculator, HP is undervalued and offers a 21.73% margin of safety.

Gurus

HP holds a strong position among the investing gurus, with 13 of them having positions. Dodge & Cox was the biggest holder on March 31 with more than 154 million shares, representing 10.79% of HP's outstanding stock and 2.91% of its portfolio.

Carl Icahn (Trades, Portfolio) of Icahn Capital Management held the second-largest position at the end of the first quarter with nearly 63 million shares, giving him a 4.4% stake in the company. Third-largest was PRIMECAP Management (Trades, Portfolio) with 36.6 million shares.

Conclusion

There has been a lot of news about HP Inc., but from an investor’s perspective, much of it is good. Although it is no longer the headliner it once was, it continues to offer reasonable returns to shareholders, especially when we consider its dividends plus share buybacks.

Quite a few gurus own the name. It has reduced its debt substantially, but its operating margin has shrunk. The dividend yield, at around 4%, is respectable, as is the payout ratio, and we see its cash flow appears to be up to the challenge. Buybacks have been consistent and material, while the stock appears to be undervalued.

Overall, HP is worthy of the attention of income investors, but if the margins were rising rather than falling, it would be a more compelling case.

Disclosure: I do not own shares in any companies named in this article and do not expect to buy any in the next 72 hours.

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About the author:

Robert Abbott
Robert F. Abbott has been investing his family’s accounts since 1995 and in 2010 added options -- mainly covered calls and collars with long stocks.

He is a freelance writer, and his projects include a website that provides information for new and intermediate-level mutual fund investors (whatisamutualfund.com).

As a writer and publisher, Abbott also explores how the middle class has come to own big business through pension funds and mutual funds, what management guru Peter Drucker called the "unseen revolution."

Visit Robert Abbott's Website


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