On Tuesday afternoon, Hewlett-Packard (HPQ +0.83%) reported EPS of $1.01 for its fiscal Q4. Most important, while some of its big-tech peers such as IBM have seen intensifying pressure on revenue, Hewlett-Packard's revenue of $29.1 billion was down just 1% year-over-year in constant currency. That was more than $1 billion ahead of the average analyst estimate.
Investors need to understand and accept that Hewlett-Packard is not a growth company at this stage in its life. The company has a few product lines that are growing strongly, but it is exposed to areas like the PC market that are probably in permanent decline.
However, once you move past the "growth question," Hewlett-Packard stock looks like a bargain. The company has stabilized its profitability, generates very strong cash flow, and has plenty of room for margin improvement -- and earnings growth -- over the next two to three years. Despite these positive signs, it trades for less than half of the market's earnings multiple!
Printing strengthens again
Hewlett-Packard's printing business has been its strongest asset throughout the recent turnaround process. HP turned in another solid printing performance last quarter: while revenue declined 1%, hardware unit sales increased by 6%, with particular strength on the commercial side. This was offset by a 4% decline in revenue from supplies.
Even though the shift from supplies to hardware would typically be bad for margins, HP was able to expand its printing operating margin to 17.7%. As a result, pre-tax earnings rose to $1.071 billion, up from $908 million in the previous quarter and $1.067 billion last year.
The modest earnings increase in the printing group actually understates the strength of HP's results. Earlier this year, HP had slightly too much channel inventory of printing supplies. HP therefore reduced its channel inventory in Q4, meaning that sales to end-users were higher than the reported figure. Currency fluctuations also reduced supplies revenue by 3.5 percentage points last quarter.
The return to growth in printer unit sales is a great sign for Hewlett-Packard. The company makes money in the printing business by selling supplies like ink and toner. By selling more commercial printers today, HP guarantees itself a long-term stream of high-margin ink and toner sales. (Few businesses try to cut corners by buying lower-quality generic ink and toner.) Thus, Hewlett-Packard's printing business is well positioned to deliver strong earnings and cash flow for the foreseeable future.
Return to growth in enterprise
The most surprising part of HP's Q4 performance was the return to revenue growth in the Enterprise Group, which sells servers, storage, networking, and related hardware and services. While revenue was up only 2% year over year, that represents the first increase in two years.
From a profitability perspective, Enterprise Group performance was less impressive: pre-tax income declined 10% year over year. Unfavorable mix shifts and a server pricing war were the key culprits.
Still, Hewlett-Packard performed well compared to peers in a tough macro environment. For comparison, IBM's last earnings report disappointed many investors as a drop-off in public sector IT spending in China contributed to a 4% revenue decline. Cisco Systems has also seen weak demand recently.
Since both IBM and Cisco are generally viewed as well-managed companies, it is pretty clear that the economy -- more than company-specific issues -- is holding Hewlett-Packard back at this point. This is encouraging, because it suggests that when economic conditions improve, Enterprise Group profitability will rebound.
Foolish final thoughts
My colleague Tim Brugger recently raised a number of important points in his more skeptical take on Hewlett-Packard's recent earnings report. HP's revenue and earnings both declined year-over-year last quarter, despite better-than-expected performances in several business units.
That said, several parts of Hewlett-Packard's business now seem to be on the mend. With more cost cuts to come, profitability should improve, particularly when the global economy heals. HP is also projecting a return to earnings growth next quarter (albeit only modest growth). Finally, it continues to generate strong cash flow, and has paid down $12 billion of debt over the last two years, putting it in a better position to return cash to shareholders.
Despite these pockets of strength, HP trades for less than eight times earnings. This type of valuation is usually reserved for companies that are in grave danger due to an excessive debt load or rapidly declining earnings. Hewlett-Packard doesn't fit either of these criteria today. This makes it one of the better values in the stock market today.
