Fear of the Future Outweighs HP's Great Quarter

After the market closed Tuesday, Hewlett-Packard (NYSE: HPQ) announced a nice earnings beat -- and lousy guidance. With a new CEO, it's especially tough to interpret the mixed signals.

Upside surprise
Non-GAAP EPS for HP's fiscal first quarter was $1.36, compared with guidance of $1.28 to $1.30 and the consensus estimate of $1.29. Revenue of $32.3 billion was shy of the $33 billion consensus. Positives included a 40 basis point improvement in operating margin year-over-year, driven by a 150 basis point uptick in gross margin and helped by "benign" component pricing.

There was a lot to like about the quarter. Although revenue grew only 4%, operating cash flow increased 28% year-over-year. HP enjoyed strength in commercial hardware, including servers, networking, PCs, and printers. In services, margins expanded and megadeal signings hit a record. Printer hardware strength bodes well for future high-margin consumables demand.  

Disappointing guidance
Current quarter guidance included non-GAAP EPS of $1.19 to $1.21, versus an analyst estimate of $1.26, and revenue of $31.4 billion to $31.6 billion, versus a consensus forecast of $32.6 billion.

It's no wonder the stock got whacked today.

What's more, HP effectively guided down the second fiscal half. In November 2010, management issued fiscal 2011 (ending in October 2011) non-GAAP EPS guidance of $5.16 to $5.26. On Tuesday, it raised that guidance to $5.20 to $5.28.

But with first fiscal quarter EPS coming in $0.06 to $0.08 above guidance, HP should have raised full fiscal year guidance by the same amount. Instead, it raised fiscal year guidance by only $0.04 on the low end and $0.02 on the high end, which in effect lowered guidance for the remaining three quarters by $0.04. (See table below.)

Source: Company reports and The Motley Fool.

Even with the lower implied guidance, HP must have an unseasonably strong second half. When asked about this on the earnings call, management indicated it expects some of its "opportunities" -- cloud computing, China, new webOS mobile devices, short-term services contracts, and consumer PCs -- to show improvement.

Management noted that HP executed well in a "challenging" consumer PC environment, has "opportunity" to drive growth in services and was "investing to lead" in cloud and connectivity. Why is it that cross-(Silicon) Valley rival Apple (Nasdaq: AAPL) doesn't seem to notice consumer "challenges"? And aren't "opportunity" and "investing to lead" fancy ways of saying a company is behind and working like mad to catch up?

Investors are thus left hoping that HP is better at following through on its self-improvement plans than the average person is at sticking with New Year's resolutions. Experienced investors know, however, that it's not unusual for a company to fall short of such plans.

Is the new CEO low-balling?
HP's new CEO, Leo Apotheker, is relatively unknown. By comparison, his immediate predecessor had a reputation for low-balling guidance. Before that, CEO Carly Fiorina was known for often being too ambitious with guidance -- and frequent earnings misses. Until investors get a good sense for where Apotheker falls on this spectrum, it's hard to assess if he is setting himself up for easy success by lowering expectations early on or if Tuesday's guidance is truly ominous. That kind of uncertainty pressures P/E ratios.

Slowing EPS growth
Even if HP makes guidance for the remainder of the fiscal year, EPS growth will slow to 10% to 12% in the back half. That's not a bad rate, especially given the stock's P/E ratio of only 9.9 at Tuesday's closing price of $48.23. The trend, however, is disconcerting.   

Sources: Company reports and The Motley Fool.

You could do worse
On the bright side, HP appears to be in better shape than value trap Dell (Nasdaq: DELL). For starters, HP maintained its No. 1 position in PC profit, revenue, and market share.

Revenue in high-growth, high-margin storage grew 14% from the year-ago quarter for HP, compared with a 4% decline for Dell. At HP, industry-standard server revenue grew 17%, and networking, helped by an acquisition, grew 183%. Dell's services, storage, and networking revenue combined grew 22%.

HP's higher margins also make it less sensitive to rising input costs than Dell. In their most recent quarters, HP reported GAAP operating margin of 10.5% compared with Dell's 7.3%.

Foolish takeaway
While there was much to like about HP's most recent quarter, the outlook is cloudy and appears to be deteriorating. It will likely be at least a quarter -- probably longer -- before investors get a better sense for where the company is headed.

Meanwhile, Apple is firing on all cylinders  in consumer IT and trades at a compelling -- given its growth rates -- P/E ratio of 19. IBM (NYSE: IBM), which is leading the charge in enterprise IT, trades at an attractive P/E ratio of 14 and offers a 1.6% dividend yield.

More on HPQ:

• HP Board Shaken: Will the Stock Stir?
• Apple Takes a Bite of HP
• It's the Tablets, Stupid