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Hewlett-Packard Company (HPQ): Relational Remains Concentrated

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The investment fund Relational Investors runs a heavy concentration, with 50% of its public-equity portfolio invested in its top four stocks. Ralph Whitworth founded Relational in 1996. The investment fund now manages some $5 billion and employs a strategic block investment strategy. Per the fund’s recent quarterly filing with the SEC, outlined below are the fund’s top four stock picks (check out Relational’s portfolio).

Betting on tech turnaround

Relational’s top stock holding is Hewlett-Packard Company (NYSE:HPQ), making up 15.8% of its 13F portfolio. HP’ portfolio of products includes printers, PCs and software. One of the big overhangs of the stock is the fact that the PC market is slowing; HP is the leading PC company with 14.8% of the global market share.

The company is also one of the leaders in printer sales, which is yet another overhang, given the decline in printer thanks to digitization. However, Hewlett-Packard Company (NYSE:HPQ) is moving toward seeking out new opportunities in enterprise, including the cloud-computing market. As well, the tech company has made a foray into the tablet market.

In its recent earnings announcement, HP posted fiscal 2Q EPS that blew past the company’s outlook and consensus estimates. Hewlett-Packard Company (NYSE:HPQ) posted EPS of $0.87, compared to management’s $0.80 to $0.82 outlook and consensus of $0.81. What’s more is that HP managed to generate $3.6 billion in cash for the quarter, up 44% from the prior-year’s quarter.

Hewlett-Packard CompanyHowever, despite the good news, HP’s biggest drag on revenue is its largest segment. Personal systems saw revenue down 20% year-over-year, while printing revenue was down 1%, enterprise down 10%, enterprise services down 8%, software 3% and financial services down 9%. As investors can see, the road to recovery is still long and winding for HP.

Following smart money

The second-largest stock holding at the end of the first quarter was Hess Corp. (NYSE:HES), which accounts for 12.6% of the fund’s 13F portfolio. Billionaire Paul Singer of Elliott Management has been battling with Hess since early 2013, fighting for change in management. Elliott believes that the company has under-performed due to poor oversight by a non-independent and under-experienced board.

Elliott got a big win last week when Hess Corp. (NYSE:HES) announced it would support Elliott’s nominees to the board. The longer-term goal of Elliott is to push Hess to break up its U.S. and international operations (check out Elliott’s latest moves).

Hess Corp. (NYSE:HES) is also working through a transition from an integrated oil and gas company to an exploration and production company  Hess has closed its Port Reading, N.J. refinery, which recently marked its complete exit from the refining business. Hess is also looking to sell off assets in Indonesia and Thailand as well as its terminals, retail, energy marketing and trading businesses in downstream.
Elliott believes that longer term, with the break up of operations, the stock could easily reach $126 per share, upside of 80%. The company appears to be a long-term buy as Elliott begins to gather other hedge fund support from the likes of Relational.

Big bets on industrials
Illinois Tool Works Inc. (NYSE:ITW) ranks third in Relational’s portfolio, accounting for 11.7% of its portfolio. Illinois is a manufacturer of a diversified range of industrial products, operating across eight segments, including transportation, power systems, food equipment and construction products. The company has solid ties to the economy, in that a rebounding economy should help boost the company’s performance.

A few of the company’s initiatives for growth include acquisitions  During 2012, Illinois Tool Works Inc. (NYSE:ITW) spent some $730 million on acquisitions and gained annualized revenue of approximately $500 million. Meanwhile, the company is also dumping other non-core and less-profitable businesses, including divestment of its Decorative Surfaces segment.

For 2013, management expects organic revenue performance of flat to 2% growth.  Analysts expect the company to grow EPS by just over 4% for 2013 year-over-year. The growth does not appear to be very robust and its PEG ratio is close to 2.1, thus, investors might be best served waiting for a pull back in the stock.

Another bet on the industrial industry is Ingersoll-Rand PLC (NYSE:IR). Ingersoll is Relational’s fourth-largest stock holding and accounts for 9.9% of its portfolio. The company manufactures various industrial and commercial products for uses in climate control, industrial technology and security.

The big tailwind for Ingersoll should be a rebound in the U.S. residential housing market, with the residential-systems segment expected to see 6% revenue growth in 2013 year-over-year, versus the company wide revenue growth of only 3%.

Ingersoll reported 1Q EPS of $0.42, up from the $0.31 reported in the same quarter last year, and a penny above consensus estimates. The company plans to spin-off its security segment, which should help it to refocus operations and capitalize on a broader economic recovery. From a valuation standpoint, Ingersoll trades at around 17.5 times earnings, which is below some of its top peers; Stanley Black & Decker, Inc. (NYSE:SWK) trades at 32 times and Lennox International Inc. (NYSE:LII) trades at 23.5 times.

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