The following is republished from Brian Gilmartin’s Fundamentalis blog on October 4, 2012
While perusing our internal valuation spreadsheets this past week, it is hard to believe some of these valuations on the PC-related names like Intel (INTC), Microsoft (MSFT), Dell (DELL) and Hewlett-Packard (HPQ).
Talk about cheap, and as I listen to the fat-box and read the Wall Street research every day, all I can think of is the famous turn of phrase by the great Mark Twain, “news of my death has been greatly exaggerated”. And yet there is no question the PC sector has problems as we hear daily about the “cyclical vs. secular” issues.
Hewlett-Packard’s (HPQ) pre-announcement Wednesday night is pushing all the PC-centric the stocks even lower on Thursday.
There are three somewhat temporary, and what could be permanent issues that have depressed sector valuations in my opinion, to a degree, where we think investment reward far outweighs the risk:
1.) The Win8 launch has supposedly cleared inventory from the channel, and slowed down channel loading in advance of q4 ’12, although analyst commentary seems mixed on this. Some analysts say Win8 is not a factor, and CIO’s are not prepping for an upgrade cycle, while some say there are enough positives about Win8 that it could help drive PC upgrades. My own opinion is that Win8 could drive upgrades after 6 – 9 months out, after the initial bugs are worked out, but the point is channel inventory is leaner (from what we hear) than any point in the last two – three years.
2.) The secular ascendancy of Apple and the tablet / smartphone. There is no question that this AAPL tsunami is generational in nature, but i also wonder if it will be so dominant that the majority of businesses will convert to Apple hardware and the Leopard o/s, and do all of their word processing and spreadsheet functions on smartphones and tablets. (As a geeky analyst and portfolio manager, I would have hard time updating a 600 line Intel Excel spreadsheet over a smartphone or tablet.) One thing that struck me when I walked around the Apple store here in downtown Chicago was that the “Office” box, which is Microsoft’s Mac version, and which would allow Microsoft applications to run on the Mac, was buried far in the corner of the Apple store. I have yet to get the sense that Apple was interested in the enterprise software market, i.e. the typical Office applications, like Word, Excel, PowerPoint, etc.
3.) The “macro” – there is no question, Europe, Southeast Asia, and China are growing less slowly or in fact contracting, not to mention the US large-company market. This plays into #4.
4.) This is a personal opinion but PC and laptop growth tends to correlate closely with corporate job growth and non-farm payroll growth, and for most of the last 12 years, and particularly off the ’08 – ’09 recession, non-farm payroll growth has been below average. The 1980′s and 1990′s were decades that saw the secular build-out of corporate i/t: servers, laptops, PC’s, email and the internet. The 2000′s have been all about personal productivity and Apple and the smartphone have certainly been well positioned for that. While i think that PC’s will lose SOME market share to tablets and such, once the economy returns to the +200k – +300k jobs that it is capable of creating every month, in a normal, healthy US economy, then it is my opinion that you will see PC’s return to a mid to high-single digit annual growth rate every year.
The source can’t be recalled, but PC growth the last three years was +12% in 2010, +7% in 2011 and now if it is +2% this year in 2012, we might be lucky. Does that signify something temporary (cyclical) or something permanent (secular), and my best opinion is that given the current extreme negative sentiment environment surrounding PC’s, it is probably a combination of both.
The attached spreadsheet summarizes the valuation metrics for the 4 PC-related companies we follow.
Here is a quick update on the PC-related names we follow in the sector. (There may be more, but we either own some of these stocks or follow them closely.)
Our favorite in the group right now is Microsoft, since the Win8 is an identifiable catalyst that will occur late October. Plus as a software company, I just don’t think there is a whole lot of downside to MSFT even with an ugly calendar q3 ’12 (and expectations are very low coming into the October earnings release.)
Intel is next, although we are hoping to but one final slug between $21 and $22 per share. Intel at 7(x) EV to cash-flow, with a 4% dividend yield is just way too cheap. However it is a hardware company with formidable capex so INTC has operating leverage risk. I think INTC beats on q3 ’12 and the stock bottoms here shortly.
Hewlett is the cheaper of the two PC makers (according to the attached Word doc). We haven’t owned HPQ since the late 1990′s, but it is too cheap to ignore here for longer-term patient accounts. Wednesday night’s preannouncement is pushing the stock lower, and I just listened to Meg Whitman’s interview with David Faber on CNBC. Is she in denial ? Possibly, but then so is Michael Dell.
Dell is the the least interesting of the two primary PC makers probably because after being a loyal Dell PC and laptop owner the last 15 years, I can’t buy another one. Their products (at least the one’s we’ve bought) are total crap. We last bought a Dell in 2010 at a Best Buy and the AMD driver now keeps failing on me every hour or so (forcing me to save this post every 10 minutes along with all my other Word and Excel work) thus we will be buying a new PC shortly, just not from Dell.
To conclude, and just to be clear, it isn’t that we don’t see risks owning PC-related stocks, it is just that our opinion is that the very inexpensive valuations and the overwhelmingly negative sentiment has resulted in a favorable risk-reward for longer-term investors (in our opinion). These stocks are too cheap to pass up. However, Microsoft and Intel are easier buys here. We are still waiting to see if HPQ and Dell will form a base.
Valuations are screamingly cheap, sentiment is downright horrid, and technicals – well, technical are ugly.
be patient. We are, and i think it will pay off once there is healthy economic growth.
Long INTC, MSFT (waiting a little while longer on HPQ and DELL. Long AAPL too. )
Trinity Asset Management, Inc. by:
Brian Gilmartin, CFA