HP's (HPQ 0.37%) stock recently popped after the PC and printer maker's third-quarter earnings beat analysts' expectations. Its revenue declined 2% year-over-year to $14.3 billion, but still beat estimates by $1.01 billion. Its adjusted earnings fell 16% to $0.49 per share, but also topped estimates by $0.06.
Those headline numbers seem weak, but there were a few bright spots throughout HP's report. Unfortunately, those scattered embers probably won't ignite a rally anytime soon.
Image source: HP.
HP's key challenges
HP generated 72% of its revenue in the third quarter from its personal systems business, which sells desktops, laptops, and workstations. The remaining 28% came from its printing business, which sells printers and supplies.
HP's personal systems business has generated steady growth in recent years, buoyed by stable demand for its higher-end laptops, convertible devices, and gaming PCs. The COVID-19 crisis also lit a fire under this business as remote work, distance learning, and stay-at-home measures boosted sales of new PCs.
However, HP's printing business has been struggling, due to long hardware upgrade cycles, a shift toward paperless workplaces, and competition from generic ink and toner makers. Those headwinds are all disrupting its razor-and-blades model, which requires HP to sell lower-margin printers to secure higher-margin supply revenue over longer periods. The COVID-19 crisis exacerbated that pain across the enterprise market.
How did those businesses fare?
Here's how HP's two main businesses fared during the third quarter:
|
Segment |
Revenue |
Growth (YOY) |
Growth (QOQ) |
|---|---|---|---|
|
Personal systems |
$10.4 billion |
7% |
25% |
|
Printing |
$3.9 billion |
(20%) |
(5%) |
Data source: HP. YOY = Year over year. QOQ = Quarter over quarter.
The personal systems unit's growth marked a significant improvement from its 7% decline in the second quarter, which was throttled by pandemic-induced supply chain disruptions. The resolution of those issues, along with elevated demand for new PCs throughout the crisis, enabled its growth to accelerate significantly into the third quarter.
Image source: Getty Images.
Within that business, a 42% year-over-year jump in consumer revenue easily offset a 6% decline in its commercial revenue. Its total notebook shipments surged 32% and offset a 30% decline in desktop shipments. The unit's operating margin dipped 10 basis points to 5.5%, but the segment's robust revenue growth lifted its operating profit for the 11th straight quarter.
In the printing business, HP's commercial hardware revenue declined 37% year over year while its supplies revenue fell 19%. However, its consumer hardware revenue rose 7% as remote work and stay-at-home trends generated fresh demand for home printers. Despite that slight improvement on the consumer front, the unit's loss of its higher-margin commercial and supply revenues still reduced its operating margin by 340 basis points to 12.2%.
HP's contracting operating margins in both segments reduced its total operating margin 160 basis points to 7.2%. It tried to offset that contraction with $953 million in buybacks, but its adjusted EPS still declined sharply.
Better-than-expected earnings growth
HP didn't provide any top-line guidance, but it expects its fourth-quarter adjusted EPS to decline 10%-17% year over year and for its full-year EPS to dip 2%-4%. Those growth rates aren't impressive, but HP's full-year EPS guidance surpassed analysts' expectations for a 6% decline. HP expects to generate $2.5 billion to $3 billion in free cash flow (FCF) for the full year, down sharply from its FCF of $4 billion last year.
During the conference call, CEO Enrique Lores declared HP would still return "100%" of its FCF to investors "over the long term, unless higher return on investment opportunities emerge." CFO Steve Fieler also said HP remained "committed to a robust dividend," which suggests its forward yield of 3.6% remains safe in this volatile market.
HP didn't provide any longer-term forecasts, but analysts expect its revenue to dip 1% next year as its earnings grow 9%. Those growth rates are weak, but they're reasonable for a stock that trades at just eight times forward earnings.
But HP still faces significant headwinds
HP's low valuation and high dividend could set a floor under its stock, but the company still hasn't resolved its biggest problems.
The personal systems segment's COVID-19 boost will likely fade over the next few quarters, and the unit still faces intense competitive pressure from rivals like Lenovo (LNVGY 1.54%) and Dell (DELL 0.26%). Neither company is burdened with a massive legacy printer business: Lenovo doesn't sell first-party printers, and Dell stopped selling printers two years ago.
The growth of HP's consumer printing business is encouraging, but that momentum could fade when the pandemic ends. Meanwhile, HP's withering printing supply business continues to weigh down its margins. That pressure will likely force HP to spend more of its FCF on buybacks, which is unsustainable over the long term because its declining net income will throttle its FCF growth.
Simply put, HP cleared Wall Street's low bar with its third-quarter earnings and guidance, but it faces the same old problems. Therefore, investors should stick with other mature tech stocks until HP stabilizes its ailing print business.
