Hewlett-Packard - Turnaround Gains Traction

| About: HP Inc. (HPQ)

Shares of Hewlett-Packard (HPQ) rose up to 7% in after-hours trading on Thursday. The technology company reported a decent set of first quarter results for 2013 after the market close.

First Quarter Results

Hewlett-Packard reported first quarter revenues of $28.4 billion, down 6% on the year. In constant currencies revenues would have fallen by 4%. Revenues comfortably beat analysts consensus estimates of $27.8 billion.

The company's operating margins compressed by 60 basis points to 6.2%, resulting in GAAP earnings of $1.2 billion, or $0.63 per share. While GAAP earnings fell by 14%, they comfortably beat HP's own guidance of $0.34-$0.37 per share.

On a non-GAAP basis, earnings fell by 12% to $1.6 billion as non-GAAP earnings per share fell by 10 cents to $0.82 per share. Earnings comfortably beat consensus estimates of $0.71 per share.

CEO Meg Whitman commented on the past quarter, "We beat our non-GAAP diluted EPS outlook for the quarter by $0.11 per share, driven by improved execution, improvement in our channel and go-to-market efforts and the impact of the restructuring program we announced in May 2012. While there's still a lot of work to do to generate the kind of growth we want to see, our turnaround is starting to gain traction as a result of the actions we took in 2012 to lay the foundation for HP's future."

Segmental Performance

HP witnessed weakness in all of its segments:

The personal systems segment reported a 8% decline in revenues, coming in at $8.2 billion. Notably the sales of notebooks (-16%) was weak, partially offset by a 4% increase in desktop sales. Operating margins roughly halved to 2.7%, down from 5.2% in the first quarter of 2012. Despite the weakness in the overall PC market, HP managed to grow its market share by 1.4%.

Printing revenues fell by 5% to $5.9 billion. Despite the weakness in revenues, operating margins rose by 3.9%, coming in at 16.1%. Product innovation, including new multi function printers and document workflow products, as well as new ink technology, boosted margins.

The enterprise group reported a 4% decline in revenues, coming in at $7.0 billion, driven by weakness in Europe, Middle-East and Africa. Operating margins fell by 2.8% to 15.5% as a result of declining revenues.

Total enterprise service revenues fell by 7% to $5.9 billion. Operating margins of the division fell by a percent point, coming in at 1.3%. Yet HP is pleased with operating margin stabilization and new orders.


For the current second quarter, Hewlett-Packard guides for non-GAAP earnings of $0.80-$0.82 per share. GAAP earnings are expected to come in between $0.38-$0.40 per share. The company expects to take $0.42 in charges related to amortization of intangible assets, restructuring charges and acquisition-related charges.

In comparison, these charges amounted to "only" $373 million, or $0.19 per share, during the first quarter.

The company sticks to its previous issued full year forecast of non-GAAP earnings of $3.40-$3.60 per share, with diluted earnings per share coming in between $2.30 and $2.50.

Whitman commented on the outlook, "Our primary focus is to deliver on the full year outlook, and I feel good about the rest of the year. We'll be bringing a number of new programs and disruptive innovations to market in the coming quarter, and we expect the benefits from our restructuring will accelerate through fiscal 2013."


HP ended its first quarter with $12.6 billion in cash and equivalents. The company operates with $28.3 billion in short and long term debt, for a net debt position of roughly $15.7 billion.

The company is on track to report annual revenues of approximately $115 billion for 2013. Based on the GAAP earnings forecast, earnings could come in between $4.5 billion and $5.0 billion.

Factoring in a 7% jump in after hours trading, the market values HP at roughly $35 billion. This values the firm at 0.3 times annual revenues and 7-8 times annual earnings.

Despite the operational difficulties, HP still pays a quarterly dividend of $0.132 per share, for an annual dividend yield of 3.1%.

Some Historical Perspective

Despite the fact that the turnaround gains traction, long term investors are still suffering. Shares are still down roughly 40% over the past year alone, but have recovered from lows below $12 back in November of 2012. Shares rallied back in December and continued their rally into 2013, with shares trading around $18 at the moment.

Between 2009 and 2012, HP managed to report a modest revenue increase from $114.2 billion to $119.9 billion. The problem is that the company was forced to report a $12.6 billion loss over the past year as the company experienced serious weakness in several of its core markets.

To make things worse, the company took multi-billion write-downs on too expensive acquisitions it has made in the past. Ironically, the acquisitions which were meant to transform the business, put the company into deeper problems.

Investment Thesis

Meg Whitman has been the new CEO of HP for almost one and a half years now. In May of last year, she announced that the company would cut 27,000 jobs by the end of 2014, in an attempt to save between $3.0 and $3.5 billion per annum.

It is well documented that HP continues to experience weakness in core business units such as personal computers, printers and servers. Worse, the company blew a lot of money by making wrong and too expensive acquisitions, highlighted by the $8.8 billion impairment on its Autonomy acquisition.

Investors are relieved in the short term with the latest results. Both revenues and earnings beat low consensus estimates, but at least there were no new nasty surprises. Upbeat comments from Whitman for the remainder of 2013 are a cause for cautious optimism as well. Despite the modest improvement, Whitman warned that it could take until 2015 and 2016 before the company has fired up all of its cylinders.

Yet she confirmed that there are no plans to break up the business, but speculation about a break-up or a leveraged buyout might continue. A good market sentiment and record low interest rates have fuelled large deals in recent times. Troubled competitor Dell (DELL) will be taken private, followed by another multi-billion deal of H.J. Heinz (HNZ).

HP continues to remain on track with its restructuring plan. The company did not surprise the market with further write-downs, it laid off 3,500 workers during the quarter, showed a nice reduction in its net debt position, and reported strong revenues and earnings. The company is not out of the woods, but there does not appear to be an imminent danger.

For investors with a higher risk tolerance, one could bet on a continued recovery or a possible take-out given the strong financial market conditions. Shares could easily touch upon $20 in the short to medium term if momentum continues. Be aware that the company remains vulnerable for an economic set back.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.