Please ensure Javascript is enabled for purposes of website accessibility

Hewlett-Packard Company Continues to Get No Respect

By Adam Levine-Weinberg – Feb 24, 2014 at 11:00AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

In many respects, Hewlett-Packard Company is outperforming top rivals IBM and Cisco, but it still gets less respect on Wall Street.

Hewlett-Packard Company (HPQ -3.12%) reported solid first-quarter results last week, including the first increase in non-GAAP EPS since 2011. In constant currency, revenue also increased for the first time since 2011.

Despite HP's improving trajectory, the company still isn't getting much respect from investors. HP shares trade for just 8 times earnings -- about half the average for the broader market. By contrast, Cisco Systems (CSCO -0.66%) and International Business Machines (IBM -1.48%) -- two competitors that have posted even weaker results lately -- trade for 10-11 times earnings.

Considering HP's bargain valuation coming into earnings, it was even more surprising to see the stock decline after HP released a good earnings report. With several of its key businesses starting to improve now, HP looks like a solid buy for long-term investors.

A big step in the recovery process
HP's recent earnings report showed that the company's three largest segments by revenue -- Personal Systems, Printing, and the Enterprise Group (servers, storage, networking, and related services) -- are all making good progress. The Enterprise Services business continues to face the biggest challenges, but HP executives expect significant improvement as the year progresses. Lastly, the relatively small software segment delivered a mixed performance.

Surprisingly, HP posted a 4% revenue increase in the Personal Systems segment. (Both major PC market research firms had projected that HP's PC sales fell in the fourth quarter of 2013.) Furthermore, HP managed to boost PC sales without sacrificing margins.

HP actually saw growth in PC sales last quarter.

HP's Enterprise Group also delivered a second straight quarter of revenue growth. Pre-tax profit fell 6% because of margin contraction, primarily because of unfavorable mix. However, this was an improvement over the prior quarter, when pre-tax profit fell 10% despite top-line growth. CEO Meg Whitman expects margins to improve going forward because of cost cuts and the growth of HP's higher-margin converged storage and networking products.

HP printer unit sales grew for the third consecutive quarter.

In the printing segment, revenue declined 2%, but this was primarily due to price deflation (which was offset by lower costs). HP's printer unit sales increased for the third straight quarter, this time by 5%. Long term, the increase in printer unit sales should drive increased sales of high-margin HP ink and toner. While printing is not a long-term growth business, the bear argument that printing is about to disappear has not been borne out either.

Causes for concern?
Offsetting the relatively good performances in these three divisions was the enterprise services business. For that segment, revenue fell 7%, and pre-tax margin contracted to just 1% because of the loss of a key customer (which had been expected).

However, HP's management still expects a 3.5%-4.5% segment margin for the full year, which would herald significant improvements in the next few quarters. If those gains materialize, it should help investors become more comfortable with HP's prospects.

HP bears also pointed out that while HP's revenue and EPS beat the average analyst estimates, the revenue gains came from the low-margin PC business and the EPS upside came from one-time items. The favorable one-time items included sales of real estate and intellectual property.

Good by comparison
While there were definitely pockets of weakness in HP's results, the company's performance looks quite good by comparison to IBM and Cisco. Whereas HP posted revenue growth in the Enterprise Group (which competes with Cisco), Cisco's revenue and adjusted EPS both declined 8% last quarter. Cisco is projecting a similar decline this quarter.

IBM has also confronted significant revenue declines recently. Revenue fell 5% in Q4 of 2013, as well as for the full year. Pre-tax earnings fell 11% last quarter, although IBM is projecting that adjusted EPS will grow more than 10% in 2014.

That said, IBM's EPS growth has been driven primarily by debt-financed share buybacks. The company's long-term debt has soared from just under $23 billion at the end of 2011 to nearly $33 billion by the end of last year.

That's not necessarily a bad thing, but over the same time period, HP has significantly improved its balance sheet. Moreover, HP has fairly consistently outperformed its own cash flow guidance in the last year and a half. This gives HP more flexibility to ramp up its own buybacks in the future to boost EPS.

Foolish bottom line
While the printing segment was the only part of HP's business to show improvements last year, the company's other hardware businesses are now starting to turn the corner. HP still has plenty of work to do, but management's success thus far should give investors confidence that the turnaround plan is sound.

Considering HP's competitors are having just as much trouble (or more), HP should be getting kudos for its turnaround efforts. Instead, shares remain stuck around $30. However, if HP continues to post profit growth over the next several quarters while moving to return more cash to shareholders, the stock should start heading toward the $40 mark.

Adam Levine-Weinberg owns shares of Hewlett-Packard Company. The Motley Fool recommends Cisco Systems. The Motley Fool owns shares of International Business Machines. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

HP Stock Quote
$29.21 (-3.12%) $0.94
IBM Stock Quote
$146.18 (-1.48%) $-2.19
Cisco Systems Stock Quote
Cisco Systems
$48.08 (-0.66%) $0.32

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 11/29/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.