HP Grows Stronger and More Profitable - Barron's

Hewlett-Packard (HPQ) has become a more profitable company under the management of CEO Mark Hurd, says Barron's Mark Veverka. More importantly, perhaps, the current slowdown might present a key opportunity for HP to expand its market share.

While other tech giants are revising earnings forecasts downwards, Hurd expects HP's earnings to continue growing through next year, albeit modestly. Consensus estimates for FY 2009 EPS come in at $3.84, up from FY 2008 EPS of $3.62. In FQ4, HP beat market expectations with EPS of $1.03 vs. $1.00 consensus and a 19% rise in revenue to $33.6B.

HP has three main businesses: imaging and printing, which makes up around 25% of revenue; personal systems, including consumer electronics, which accounts for around 36% of revenue; and technology solutions, which generates around 38% of revenue. Since Hurd's arrival in 2005, each of these units has grown more profitable. Revenue has grown to $118.4B from $80B (and is expected to reach $130B in FY '09), while EPS has more than doubled.

The emphasis on profits, along with Hurd's cost-cutting focus, have made HP a top tech defensive play. Recurring revenue of $40B doesn't hurt either, and comes mainly from items like ink supplies, outsourcing and corporate leasing. HP also has the size and diversity - in products, in market exposure and geographically - to do well even when the economy is struggling.

Another point of note is HP's revenue from the consumer market. Around 25% of HP's sales come from consumer products, and the firm boasts the third-highest consumer revenue among computer-electronics firms, behind Apple (AAPL) and printer-maker Lexmark (LXK). As such, the downturn in the consumer market has hurt HP. Interestingly, however, a drop in printer sales could mean higher overall margins since printers lose money at retail. Hurd believes a drop in printer sales isn't a bad thing in the short-term, especially considering research that shows people are keeping their printers longer.

Another important part of HP's consumer-product line are personal computers which contribute around 10% of operating profits. Across the board, PC sales are expected to fall in 2009, but HP's reliance on contract manufacturers at the plants it owns give it increased financial flexibility. In a recession, it means HP doesn't bear the cost of idled plants or workers.

The biggest boost to profits could be from HP's acquisition and integration of EDS. The addition will allow HP to compete with IBM more aggressively for big corporate deals. With operating margins over 60% and long-term contracts built in over the next three to five years, the EDS outsourcing business nicely supplements HP's recurring revenue. Aside from long-term benefits, Hurd is focused on cutting costs to benefit from the EDS deal in the short-term as well.

HP trades for 8.18 times FY 2010 estimated earnings, cheaper than Dell's (DELL) 8.32 multiple and a steal compared to IBM's 9 times estimated 2009 earnings.

• Ben Reitzes, a Barclays Capital hardware analyst, thinks shares could climb to $47 vs. Friday's close of $34.97.
• HP has "limited downside and significant upside," money manager Chuck Jones says. Shares could reach the low-50s once the stock market starts to recover.
• Hardware analyst Toni Sacconaghi rates HP a Buy and sees the stock at around $40.

::::::::::::::::::

• HP recently announced the tx2, the first multi-touch enabled notebook PC.

• HP doubled its annual holiday shutdown from one week to two. "Shutting down during a period when many employees traditionally take vacation helps HP achieve operational savings and allows employees to enjoy more time with their families."

Comments

[Hedged In:]

This is helpful data on HP's businesses, and the discussion of the printer business is particularly thought provoking. However, I'm sceptical overall on HPQ for the following reasons:

1. Mark Hurd has done an outstanding job reducing waste at HP, but that means there are fewer costs to cut now.

2. There's a reasonable likelihood that consumers will reduce spending and switch from more expensive laptops to netbooks -- see comments on netbooks here: seekingalpha.com/accou.... As the article points out, that's 10% of operating profits.

3. HPQ's corporate IT business is heavily exposed to capital spending by businesses. 2009 doesn't look as though it's going to be a rosy year for business capex.

Overall, Barron's case for HPQ's stock seems somewhat backward looking -- it's based too much on Mark Hurd's excellent track record until now. (Full disclosure: no position in HPQ, long or short.)

2008 Dec 28 03:39 AM

[Eli Hoffmann:]

You make some good points, HedgedIn. I'm also a bit miffed by Barron's playing up a jump in margins if HP sells less printers. How is a short-term boost to margin supposed to be a positive for the company if printer sales drop - in the long run costing it profitable sales of ink cartridges etc.?

2008 Dec 28 06:09 AM

[sheldon1:]

I few years ago I did a study on HP, and projeced 2 expansions, first: The merging of EDS and HP and 2nd the combining with Oracle. That combination would create a world class IT / Solution Powerhouse. Now that I see the curret direction, I will add another projection: Apple. Over and above an HP, EDS, Oracle combination which I believe will come, we are moving to a virtual world. Apple bring that plus comsumer technology leadership. It will be interesting to see how close my projections come.

2008 Dec 28 09:28 AM

[FloridaJMM:]

I believe that the article points out an OVERALL drop in the consumer market and not HP's MARKET SHARE. Therefore, the sales of supplies would remain at the current percentages of market penetration.


On Dec 28 06:09 AM SA Editor Eli Hoffmann wrote:

> You make some good points, HedgedIn. I'm also a bit miffed by Barron's
> playing up a jump in margins if HP sells less printers. How is a
> short-term boost to margin supposed to be a positive for the company
> if printer sales drop - in the long run costing it profitable sales
> of ink cartridges etc.?

2008 Dec 28 10:14 AM

[SJMDESIGN LTD:]

I am a share holder HP and the shares are standing up in good strength regarding current environment.
Mark Hurd is doing fine job. They have superior product in every aspect
If they continue to innovate with aggressive pricing the stock has tremendous upside when recovery starts hopefully in 2009.
My target price is $70.0 within 16 months

2008 Dec 28 06:43 PM

[Kunst:]

I am a former HP employee (software development, IT, and management) and current stockholder. Mark Hurd is the real deal. He will go down as one of the great corporate leaders. He is very reality- and customer-focused, works from a strategic perspective one step at a time, and displays great operational and intellectual discipline. Just as some coaches' teams consistently excel, the right leader can have a huge impact on a business. HP used to be bloated and unfocused. Now, it is a formidable competitor. HP should be a good stock for the long term.

2008 Dec 30 01:44 AM

[nmelendez:]

I hated when it bought compaq, i am/was a compaq fan. That buyout really put them up to compete with IBM in the midsize and with their new Edge servers, they're going to move up quickly. I hate HP eating up compaq but i admit, they are a great company.

2008 Dec 30 09:48 PM