By Maxim Group ($14.06, Nov. 23, 2015)

At the current valuation, we believe HP Inc. is an attractive private-equity takeout target.

Given our opinion that none of the free cash flow will be needed for acquisitions, we believe there is the potential of a private-equity consortium purchasing HP Inc. (ticker: HPQ HPQ 2.8812368236120873% HP Inc. U.S.: NYSE USD14.64 0.41 2.8812368236120873% /Date(1448402562985-0600)/ Volume (Delayed 15m) : 27711105 AFTER HOURS USD13.55 -1.09 -7.445355191256831% Volume (Delayed 15m) : 1195150 P/E Ratio 5.975510204081632 Market Cap 25588740579.4258 Dividend Yield 3.387978142076503% Rev. per Employee 347003 More quote details and news » ) at our new $17 price target and then utilizing the about $3 billion a year in free cash flow to pay down the about $22 billion in debt. We would not be surprised to see a private-equity consortium to purchase HP Inc. at an about $30 billion market cap, effectively taking seven years to pay down the debt and drive the equity value from $8 billion to $30 billion or more (depending on whether the foray into the copier market is successful).

We are upgrading HP Inc. to a Buy rating from Hold and on a pro-forma basis raising our 12-month price target from $14.50 to $17.00. With the spinout of the high-free-cash-flow-consumption Hewlett Packard Enterprise (HPE) business (for acquisitions and restructurings) and the upside drivers cited above, we are upgrading HP Inc. Although we are technically lowering our price target from $28.00 to $17.00, we are effectively raising our HP Inc. 12-month price target on a pro forma basis from $14.50 (when taking out our assigned value of $13.50 for HP Enterprise). Our new 12-month price target of $17.00 is based on a 13 times multiple on our acquisition-adjusted normalized free cash flow (where normalized free cash flow is roughly equivalent to non-GAAP net income). The 13 times multiple we use is consistent with the multiple from our entire on-premise information technology (IT) bellwether universe.

It’s also consistent with the terminal period multiple we use for DCFs for our hypergrowth companies under coverage. We expect fiscal 2016 earnings per share and normalized free cash flow to come in at the high end of management’s guidance ranges of $1.67 to $1.77 and $2.9 billion to $3.2 billion ($1.66 to $1.85 per share), respectively.

Medium-probability upside drivers leave us positively biased from at least a short to mid-term perspective. We expect four drivers to play out sometime between three months and two years from now. Specifically, these drivers are: 1) room for HP Inc. to raise the rate of free-cash-flow return from between 50% and 75% to about 90%, which implies additional upside (about 20%) is possible, in our view; 2) HP Inc. printing supplies (26% of revenue and about 53% of operating profit, according to our estimate) likely experiencing a temporary reprieve in a secular decline, based on data from the American Forest & Paper Association; 3) the potential for HP Inc. to successfully penetrate the multi-function copier market with its Page Wide Inkjet Technology (meaning an approximate 2 times Imaging and Printing Group (IPG) increase in operating profit over an about five-year period); and 4) PC operating margins expanding from our projected 3.4% in fiscal 2016 (flat year-over-year) to 5% or above. Prior peak margins were 5.9%, and competitor Lenovo [traded in Hong Kong] is also currently posting an approximate 5% PC operating margin.

-- Nehal Chokshi

The companies mentioned in Hot Research are subjects of research reports issued recently by investment firms. Their opinions in no way represent those of Barrons.com or Dow Jones & Company, Inc. Some of the reports’ issuers have provided, or hope to provide, investment-banking or other services to the companies being analyzed. Share prices at the time the report was issued and the date of the report are in parentheses.

Comments: E-mail online.editors@barrons.com

Credit Suisse

Rising non-fuel costs are an increasing concern for airline investors when considering margin trajectories in 2016-2017. Open labor negotiations are popular topics since wages are the predominant driver of higher costs. We take a closer look at each airlines’ labor situation and the timeline and process for negotiations.

2016 is a pivotal year in the industry for labor. Only two sizeable union groups ratified new contracts in the last 12 months (American Airlines Group (ticker: AAL AAL -2.5295508274231677% American Airlines Group Inc. U.S.: Nasdaq USD41.23 -1.07 -2.5295508274231677% /Date(1448402400003-0600)/ Volume (Delayed 15m) : 7519337 AFTER HOURS USD40.93 -0.3 -0.7276255154014067% Volume (Delayed 15m) : 58640 P/E Ratio 5.873219373219373 Market Cap 26662788844.0506 Dividend Yield 0.9701673538685424% Rev. per Employee 366461 More quote details and news » ) pilot and flight attendants) while there were three major rejections (Delta Air Lines ( DAL DAL -3.0775543701272055% Delta Air Lines Inc. U.S.: NYSE USD47.24 -1.5 -3.0775543701272055% /Date(1448402502706-0600)/ Volume (Delayed 15m) : 10900526 AFTER HOURS USD47.09 -0.15 -0.31752751905165116% Volume (Delayed 15m) : 210495 P/E Ratio 13.420454545454545 Market Cap 38332744032.4728 Dividend Yield 1.1430990685859441% Rev. per Employee 511958 More quote details and news » ) and Southwest Airlines ( LUV LUV -2.6121761112281443% Southwest Airlines Co. U.S.: NYSE USD46.23 -1.24 -2.6121761112281443% /Date(1448402513273-0600)/ Volume (Delayed 15m) : 7277418 AFTER HOURS USD46.1 -0.13 -0.28120268224096906% Volume (Delayed 15m) : 661552 P/E Ratio 16.960780716880066 Market Cap 30872351716.7419 Dividend Yield 0.6489292667099286% Rev. per Employee 420740 More quote details and news » ) pilots, Southwest flight attendants). We count 18 amendable contracts (with most in active negotiations) across our coverage.

As fuel has declined, labor is now by far the largest component of airlines’ cost structure, averaging 30% of total operating expenses. 2016 will mark the seventh year of industry profitability, making this the longest up-cycle in the history of the industry. High-teens operating margins are about two times those of the prior peak during the late 1990s. Following the last extended upcycle in the late 1990s, generous labor contracts led to rising wage expense that weighed heavily on industry profitability after the cycle turned in 2001. In the following 10 years, nearly every major airline filed bankruptcy enabling a substantial reduction in wage rates. As benefits from post-bankruptcy restructuring diminish and contracts are becoming amendable, wage escalation is creating upward pressure on cost structures across the industry. Upgauging and productivity initiatives should help keep nonfuel unit costs sub inflation, but for several carriers we expect 2016 or 2017 could see above inflation unit cost growth when contracts with sizeable pay increases are ratified.

Unprecedented profitability and generous wage increases from major airlines have elevated employee expectations. Pattern bargaining is prevailing as groups look to recently signed competitor contracts and demand even higher pay rates. High expectations have led to numerous rejections of initial tentative agreements as groups hope for higher wages with fewer concessions in the next go-around. Concessions come in the form of profit-sharing reductions (or elimination in the case of American Airlines) or changes to work rules (including scope, flexibility, codeshares) that allow companies to improve productivity or generate more revenue. It seems unlikely management teams will reward contract rejections with meaningfully higher economics. We expect major labor deals will not be reached until mid-2016 at the earliest.

Alaska Air Group ( ALK ALK -1.0073373958462877% Alaska Air Group Inc. U.S.: NYSE USD79.6 -0.81 -1.0073373958462877% /Date(1448402593840-0600)/ Volume (Delayed 15m) : 1129365 AFTER HOURS USD79.59 -0.01 -0.01256281407035176% Volume (Delayed 15m) : 35334 P/E Ratio 12.894238089838497 Market Cap 10142033175.2161 Dividend Yield 1.0050251256281406% Rev. per Employee 396144 More quote details and news » ) has the most visibility, facing the least level of escalation and incremental expense before 2018. American Airlines is next with fresh five-year contracts for pilots and flight attendants, but remaining groups could add an additional one to two points to 2016 cost per available seat mile (CASM)-ex growth guidance of 0-2% if signed soon. Delta’s pilot contract is amendable Jan. 1, 2016, and negotiations continue after an attempt at an early agreement failed over the summer; as with the non-pilot group though, a profit-sharing trade should cushion the impact of what is likely a mid-teens increase in pay rates. United Continental Holdings ( UAL UAL -3.0054644808743167% United Continental Holdings Inc. U.S.: NYSE USD56.8 -1.76 -3.0054644808743167% /Date(1448402507477-0600)/ Volume (Delayed 15m) : 6872746 AFTER HOURS USD56.47 -0.33 -0.5809859154929577% Volume (Delayed 15m) : 386745 P/E Ratio 3.2737752161383287 Market Cap 21831753969.0079 Dividend Yield N/A Rev. per Employee 454060 More quote details and news » ), Southwest, Allegiant Travel ( ALGT ALGT -5.122950819672131% Allegiant Travel Co. U.S.: Nasdaq USD189.83 -10.25 -5.122950819672131% /Date(1448402400328-0600)/ Volume (Delayed 15m) : 179334 AFTER HOURS USD189.83 % Volume (Delayed 15m) : 3432 P/E Ratio 19.308149233085153 Market Cap 3368946939.55322 Dividend Yield 0.6321445503871885% Rev. per Employee 509850 More quote details and news » ) and Spirit Airlines ( SAVE SAVE -3.073993471164309% Spirit Airlines Inc. U.S.: Nasdaq USD35.63 -1.13 -3.073993471164309% /Date(1448402400239-0600)/ Volume (Delayed 15m) : 2128717 AFTER HOURS USD35.64 0.01 0.028066236317709794% Volume (Delayed 15m) : 9581 P/E Ratio 8.690243902439024 Market Cap 2691170286.57556 Dividend Yield N/A Rev. per Employee 496825 More quote details and news » ) have multiple contracts up for renegotiation with varying (and widening) gaps to industry average. United’s renewed focus on expediting new and extended labor contracts make it the most likely to see deals ratified near-term.

-- Julie Yates
-- Parker Kim

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Palo Alto Networks (PANW: NYSE)
By Wells Fargo Securities ($172.02, Nov. 23, 2015)

We increased our fiscal 2016/2017 billings estimates for Palo Alto Networks to $1.78 billion/$2.40 billion, respectively, from $1.76 billion/$2.36 billion. We increased our fiscal 2016/2017 earnings-per-share estimates to $1.74/$2.88, respectively, from $1.68/$2.78. And lastly, we increased our valuation range to $218-$225 share from $208-$215. We reiterate our Outperform rating.

Palo Alto (ticker: PANW PANW 6.295779560516219% Palo Alto Networks Inc. U.S.: NYSE USD182.85 10.83 6.295779560516219% /Date(1448402408525-0600)/ Volume (Delayed 15m) : 6346060 AFTER HOURS USD182.84 -0.01 -0.005468963631391851% Volume (Delayed 15m) : 71341 P/E Ratio N/A Market Cap 14747447469.2487 Dividend Yield N/A Rev. per Employee 391697 More quote details and news » ) reported strong fiscal-first-quarter results and offered a better-than-expected fiscal-second-quarter outlook. Specifically, Palo Alto beat Wall Street billings estimates by 8% and EPS estimates by 9%. The company’s fiscal-second-quarter revenue guidance was 1.7% above expectations. Management stressed on the call that they feel good about the spending environment/pipeline and remain confident in their ability to gain market share.

Palo Alto expects fiscal-second-quarter revenue of $314 million-$318 million for a midpoint of $316 million versus our prior $307.8 million estimate and the Street estimate of $310.8 million, EPS of 38 cents-39 cents versus our 37 cents estimate and the Street’s 38 cents estimate. The 1.7% upside at the midpoint of revenue guidance relative to the Street is fairly consistent with the average upside seen over the last year. Management expects sequential operating-margin improvement through the year and a fiscal 2016 fourth-quarter exit rate of 22%-25%.

Management stressed that they feel good about the state of their business and that the spending environment remains robust. Furthermore, the company highlighted that the pipeline heading into the fiscal second quarter is healthy and that they are confident in their ability to execute and take share from competitors.

Our valuation range of $218.00-$225.00 is based on an 27.0-28.0 times calendar 2017 estimated enterprise value/free-cash-flow multiple.

-- Gray Powell
-- Priya Parasuraman

The companies mentioned in Hot Research are subjects of research reports issued recently by investment firms. Their opinions in no way represent those of Barrons.com or Dow Jones & Company, Inc. Some of the reports’ issuers have provided, or hope to provide, investment-banking or other services to the companies being analyzed. Share prices at the time the report was issued and the date of the report are in parentheses.

Comments: E-mail online.editors@barrons.com