When Hewlett-Packard (NYSE: HPQ ) reported quarterly earnings at the end of November, the stock shot up by as much as 10% following the announcement. While HP beat analyst estimates on both the top and bottom lines, the results were not good. The market often reacts to relative results, not absolute results, and HP's post-earnings surge is a prime example.
Not as bad is still not good
The fourth quarter for HP looks a lot better than the third quarter, but what it doesn't provide is any proof that the turnaround effort is working. Considering HP's third-quarter earnings a few months ago, the company appeared to have no bottom in sight, and that remains true today.
Total revenue fell by 3% as non-GAAP EPS declined by 13%. HP still generates quite a bit of cash, but most of it comes from only two places -- printing and servers. HP's printing business is somewhat of a bright spot, with revenue falling by 1% year-over-year, while operating profit is rising slightly. In my previous article on HP, I pointed out that the barriers to entry in the printing business would allow HP to maintain its margins even as revenue declined. Printing should be a major source of profit for a long time.
The enterprise group is a different story. While revenue rose by 2%, likely from HP picking up share from competitors like IBM (NYSE: IBM ) , operating margin fell both sequentially and year-over-year. With an increasing number of companies choosing cloud-based solutions over proprietary servers, the concern is that HP's server business will begin to look like HP's PC business.
Sales of personal computers fell by only 2% year-over-year, a dramatic improvement compared to recent quarters, but HP derives very little profit from the PC business. Operating margin sits at just 3%, so even significant growth would mean little for the bottom line. The services and software businesses both declined by 9%, although margins rose in both cases.
The fourth quarter was certainly better than the last few quarters, but the company is still a long way from returning to growth. It's hard to guess how far earnings will fall before this happens, which makes investing in HP a difficult proposition.
Avoiding the IBM disaster
It looks like HP was able to take advantage of the recent large decline in IBM's server business. When IBM last reported earnings, the company's hardware sales had plummeted by 17% year-over-year. While IBM saw sales of x86-based servers, the architecture used by chip giant Intel (NASDAQ: INTC ) , fall by 18%, HP reported a 10% rise in x86 server revenue.
It's difficult to tell if this gain in market share for HP is temporary or permanent. In Q3, enterprise group sales fell by 9% year-over-year, and in Q2 they fell by 10%, so this quarter's sales increase is a fairly sharp reversal of what looked like a long-term trend. The fact that margins still declined in the quarter indicates that all is not well with the server business, and declining sales in the coming quarters wouldn't be a surprise.
A strong holiday season for PCs?
PC shipments actually rose in the U.S. in the third quarter, suggesting that aggressive pricing is driving sales. One thing that will be very different about the PC market this holiday season compared to last year is the rise of Intel-powered tablets and convertibles running Windows 8. These devices are often just a few hundred dollars, comparable to mid-range Android tablets, but they have the benefit of running the full Windows operating system.
After a failed foray into tablets a few years ago, HP is looking to get back in the game. The recently announced Omni 10 is a 10" tablet with a full 1080p screen protected by Gorilla Glass 3, running the full version of Windows 8.1. Intel's Bay Trail processor allows the device up to 8.5 hours of battery life, and it will sell for just $399.
It is possible that HP will actually be able to grow its PC business with devices like this. Although margins will remain low as competitors like Dell release similar devices, Intel's new processors offer hope that the PC market may finally be stabilizing, which is good news for HP.
The bottom line
It's unclear where the bottom is for HP's profits, and this quarter's results don't justify the rise in the stock price. Although there was significant improvement, all of the same problems still exist for the company. Printing revenue is declining, as is server operating margin, and the fact that these two businesses account for most of the company's profit is not encouraging. HP is still a long way from proving that a real turnaround is under way, and it will likely take at least a few more years until anything other than pessimism is warranted.
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