Deutsche Bank continues to recommend investors to buy into Dell, Inc. (NASDAQ: DELL) and sell Hewlett-Packard, Co. (NYSE: HPQ), saying HP was expensive, compared to Dell on Enterprise Value (EV) and Free Cash Flow (FCF) metrics.
Both Dell and HP are executing strategies aimed at increasing their respective positions in the enterprise, in an attempt to drive structural margin improvement. Although the end goals may be similar, execution and specific steps taken against them are deviating dramatically. The relative performance of each is best demonstrated by earnings and cash flow revisions.
The brokerage said consensus 2011 EPS and CF estimates for Dell have increased 37 percent and 21 percent, respectively. Conversely, consensus 2011 EPS and CF estimates for HP have been cut 22 percent and 21 percent, respectively.
Surprisingly, over this time-frame, HP's EV/FCF multiple vs. Dell has expanded and HP now trades at nearly ~2x Dell on EV/FCF (this metric normalizes for capital structure and EPS quality, analyst Chris Whitmore wrote in a note to clients.
HP trades at a large premium despite similar, if not greater company-specific structural challenges resulting from years of underinvestment, restructuring (brain drain) and its comparatively high exposure to declining product areas.
The analyst said HP gets more than 70 percent of its profits from sales of Personal Computers (PC), printers and services. These major profit centers at HP remain handicapped due to a secular decline in printers, services retooling, PCs exposure to consumer, etc., with little visibility on a strategy to return each to growth.
Due to the structural nature of HP's challenges, we believe a sustainable EPS growth path will prove elusive for the next 12-18+ months, said Whitmore.
On the other hand, Dell has taken a series of smaller steps to deepen its exposure to enterprise products and now derives about 50 percent of company profit from the enterprise.
In addition, ratings agencies Fitch and Standard & Poor's (S&P) have recently downgraded those of HP. S&P lowered its corporate credit and senior unsecured ratings on HP to BBB+ from A and Fitch cut its long-term issuer default rating on HP to A from A+.
Investor sentiment and HP's multiple may wane as the PC maker labors over the next 12-24 months to pay down debt, manage large European exposure, reposition services, battle for share in PCs and fight against the secular decline in printing.
Consequently, we continue to recommend investors Sell HPQ ($20 PT) and view Dell as attractive (~3x CY12 EV/FCF); reiterate Buy, Whitmore said.
Shares of HP closed Friday's regular trading session at $27.68, while Dell ended Friday's session at $15.70.