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Vinay Singh
Vinay Singh
Articles (229) 

Why Hewlett-Packard Has Limited Upside

May 12, 2014 | About:

Hewlett-Packard (NYSE:HPQ) stepped on the gas in 2013 with shares almost doubling. Its improved performance during the fourth quarter fueled optimism about the company's recent efforts to stage a turnaround. While revenue for the period was ahead of analyst expectations at $29.1 billion, HP's adjusted earnings were also better than Street estimates at $1.01 per share.

However, the general scenario continues to remain bleak as HP's top and bottom lines fell on a year-over-year basis by 3% and 13%, respectively. In addition, CEO Meg Whitman repeated her earlier guidance of declining revenue for the financial year ending 2014. Thus, it is clear that investors have bid up shares under the hope that HP will rebound, but are they right in thinking so? Let's try and find out.

Enterprise Spending Cues

The primary reason behind HP's decent fourth-quarter earnings was a 1.8% increase in revenue from the enterprise division that accounts for roughly 25% of overall sales. In fact, the results have been a complete turnaround, considering that HP's enterprise division revenue actually fell by as much as 9% during the earlier quarter, indicating that the company may still be able to count on its corporate customers.

Not So Sure Here

A major part of HP's current enterprise division results may be attributed to the fact that a lot of companies are scrambling to upgrade to Microsoft's newest version of Windows operating system, as the latter officially ends support for the earlier Windows XP in April 2014. In effect, this might be a temporary bright spot for HP.

Moreover, HP might not see much relief from the current 10% uptick in server sales because many companies continue to move systems to the cloud, instead of purchasing expensive on-site equipment, which is the reason why companies like Amazon.com (AMZN) and Salesforce.com (CRM) are thriving in today's tech environment.

Also, declining server and networking equipment sales to HP's enterprise customers seem to have prompted competitor Cisco to predict a fall in its current quarter's revenue, the first in four years. Cisco continues to bear the brunt of a slow pickup in the economy in crucial markets such as Europe and China, a fact which HP's management has also acknowledged.

More Trouble

Apart from enterprises, the tendency among individual customers to upgrade to the newest version of Windows may also have been the reason why revenue for HP's personal systems division -- the one that includes PCs -- fell by a less-than-expected 2%. With research firm IDC predicting a continued decline in PC shipments through 2014, the gap in revenue is expected to widen further.

HP also faces the problem of competitive pricing by industry competitor and fellow PC manufacturer, Dell. After the latter's LBO, Dell faces a heavy debt burden that has prompted it to follow a "no holds barred" price-cutting policy in a desperate bid to gain more market share, a fact that has resulted in thinner profit margins for HP.

Also, HP seems destined to continue facing macroeconomic headwinds for quite some time, as the global economic recovery has been much slower than expected. The company can't even fall back on generating sales in emerging markets such as China, whose economy faces an uncertain future, a fact corroborated by rivals Cisco and IBM. Although HP has, supposedly, taken corrective measures (such as the recent appointment of Robert Mao, a market veteran, as its head of operations for China), only time will tell how things will actually shape up there.

What Next?

The only good things that can be attributed to Whitman, so far, are a substantial reduction of the company's once-massive pile of debt and an increase in free cash flow by almost $9 billion this fiscal year. But beyond that, I'm not very confident in HP's turnaround efforts, given that the company still hasn't been able to zero in on a substantial revenue stream that can offset the continued downslide in PC-based fortunes.

Although HP's planned dividend and buyback scenario are impressive and provide very good reasons to hold on to the stock, I doubt if it will be worthy of remaining in your portfolio by this time next year.

Rating: 2.5/5 (2 votes)



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