Is HP a Buy?

HP (HPQ +1.18%) lost about a quarter of its market value over the past six months due to the slowdown of its core PC and printer businesses. But after that sell-off HP trades at just nine times forward earnings, while paying a forward annual dividend yield of 3%.

With that low valuation and decent dividend, is HP an undervalued income stock -- or is it a value trap that could ensnare bargain hunters?

Image source: HP.

What happened to HP?

HP spun off its enterprise business as Hewlett-Packard Enterprise (HPE +1.42%) in late 2015. After the split, HP retained the company's PC and printing businesses.

Both units were stuck in slow-growth markets, but the slimmed-down HP revitalized its aging PC business with new convertible devices, premium notebooks, and gaming PCs. It also scaled up its printing business by acquiring Samsung's (NASDAQOTH: SSNLF) printing unit and the office equipment dealer Apogee.

Those strategies helped HP post an impressive streak of double-digit sales and earnings growth. However, that streak abruptly ended in the first quarter of 2019:

YOY = Year-over-year. Source: HP quarterly reports.

HP's personal systems business struggled with declining shipments of notebooks and desktops, which it blamed on sluggish upgrades and Intel's (INTC 3.08%) ongoing shortage of CPUs. It also lost its crown as the world's top PC maker to Lenovo last year after the Chinese company acquired a controlling stake in Fujitsu's PC unit.

HP's printing business struggled with declining sales of its higher-margin supplies due to soft demand in its EMEA (Europe, Middle East, and Africa) region and competition from online retailers selling generic ink and toner. That weakness offset the growth of its lower-margin hardware business.

HP is responding to generic competitors with cost-effective subscription plans (like HP Instant Ink), but it still expects its supplies revenue to fall 3% for the full year. This indicates that the segment's margins will contract and throttle the company's overall earnings growth.

Image source: Getty Images.

The tailwinds and headwinds

HP's revenue growth faces tough headwinds, but the company still expanded both business' operating margins last quarter.

Operating margins. Source: HP quarterly reports.

HP's PC operating margin expanded as it raised its prices to offset its shipment declines, and its printer operating margin improved as it cut costs to offset the weakness of its supply business. Those are short-term solutions, but there are long-term catalysts on the horizon.

If Intel resolves its chip shortage issues by the end of the year, PC shipments should accelerate again and give HP easy year-over-year comparisons in fiscal 2020. DRAM and NAND prices should remain low and bolster the PC unit's margins. The introduction of new devices like VR headsets could also diversify the business away from traditional PCs.

The printing business could stabilize over time as it expands its ink subscriptions, leverages its acquisitions of Samsung and Apogee's businesses to cut costs, and expands its industrial 3D printing business to diversify away from traditional printers.

HP didn't provide revenue guidance for the full year, but it expects its adjusted earnings per share to rise 5% to 10%, compared to 22% growth in 2018. Most of that growth should come from buybacks -- HP spent over 100% of its free cash flow on buybacks during the first quarter, and those buybacks should buoy its earnings throughout the rest of the year.

So is it time to buy HP?

I don't plan to sell my shares of HP anytime soon. However, it should take a while for HP's stock to recover, and other mature tech stocks currently have brighter growth prospects and pay comparable dividends. Therefore, investors who don't own HP should stick to the sidelines and wait for its two core businesses to recover before jumping in.