Hewlett-Packard Bonds Offer Value Amid Headwinds

Since Hewlett-Packard (HPQ) CEO Meg Whitman provided earnings guidance for 2013 in early October, investors with disappointment on their minds have targeted and attacked anything related to the company. The stock has tumbled by a staggering 22.8 percent from October 2 through yesterday. Similarly, yields on HPQ bonds have increased in a time where U.S. Treasury rates have either stayed the same or for longer maturities, have fallen. While the announcement is upsetting for stockholders, the fact is that the outlook should be sufficiently constructive from a credit perspective.

In particular, management’s goal of improving the company’s credit profile via debt reduction should be a strong positive for bond holders. The company hopes to return to a mid-single A credit rating from its current low A3/BBB+ rating by Moody’s/S&P (Watch Negative by Moody’s) over the course of the next several years. Furthermore and despite the competitive challenges the company faces across all of its business segments, the credit fundamentals suggest that HPQ bonds are cheap and are a relative value opportunity, especially when compared with debt issued by other Technology companies of similar investment grade ratings.

On October 3, 2012 at HPQ’s turnaround strategy meeting with security analysts, CFO Cathie Lesjak provided the outlook of the company for 2013. While the company provided non-GAAP earnings per share guidance in the range of $3.40 to $3.60 which fell short of the average analyst’s expectations of just above $4.00 per share, the management team stressed its priority of debt reduction and repairing its balance sheet in the next several years. The hope is to ultimately reduce its cost of capital by improving its credit rating one notch. In particular, Lesjak said at the Trade Monster’s Bond Trading Center , HPQ 4.65% Coupon Maturing on December 9, 2021 (CUSIP 428236BV4) is currently trading at a dollar price of $99.67 which translates to a yield to maturity of 4.69%. Comparatively, XRX 4.50% Coupon Maturing on May 15, 2021 (CUSIP 984121CD3) can be purchased at a dollar price of $106.14 which equates to a yield of 3.65%. So by investing in HPQ, an investor can pick up an additional 104 basis points based off of today’s levels while assuming similar risks.

For investors who do not want to take on that much interest rate risk by extending with a longer maturity but would like to capture some carry, the short end of the yield curve provides some opportunities. An investor can capture 3.16% on a yield to maturity basis by owning HPQ 2.60% Coupon Maturing on September 15, 2017 (CUSIP 428236BW2) at a dollar price of $97.52. This is a 101 basis point pickup over XRX 2.95% Coupon Maturing on March 15, 2017 (CUSIP 984121CF8) which at a $103.29 dollar price is yielding 2.15%.

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All of the aforementioned bonds were highlighted by finding the best yield given the dollar price. Some bonds yielded higher but at a cost of a higher dollar premium.

Furthermore, keep in mind that corporate bonds trade over-the-counter. So, prices and yields can vary depending on the broker you use. The best suggestion is to use a broker that offers the most visibility and price transparency for the corporate bond market. This can be achieved by comparing the price to buy and the sale price (aka bid-ask spread). The closer the differential usually means the better the liquidity.

As always, every bond investor should perform their own due diligence when making their investment decisions.

Disclaimer: The above content is provided for educational and informational purposes only, does not constitute a recommendation to enter in any securities transactions or to engage in any of the investment strategies presented in such content, and does not represent the opinions of Bondsquawk or its employees.

Written By: Bondsquawk