Hewlett-Packard (HPQ) is fast becoming a successful turnaround story. The stock has gained almost 50% over the past three months. The main reason for the increase in the stock price was better than expected results. The company surprised the market, and analysts at UBS AG (UBS) raised the rating on the stock. The stock went up by 14% in a day, recording the biggest rally in a single day in five years. In addition, a positive outlook for the next quarter has also helped the stock maintain upward price movement. However, it will be too soon to call it a successful turnaround - although the signs are extremely encouraging.
The technology sector is one of the most volatile sectors, and the participants need to be on their toes all the time. The trends and technology change at a rapid pace in this sector, and consumer preferences can also change quickly. HP operates in six segments, and five of the six segments showed a decline in revenues. Two of the most important products for HP are PCs and Printers. PC and Printer segments are showing a continued decline in sales, falling in the first quarter by 8% and 5%, respectively.
Declining Product Markets and Economies of Scale
Printers and PCs amount to almost half of the revenue of the company. Acquisitions made HP the biggest PC vendor in the world. However, the global PCs market is on the decline and the participants are losing revenue. Nonetheless, being the biggest vendor allows the company to have economies of scale. Printer and PCs segments are always the first to come under scrutiny by the market, and rightly so due to the contribution of these segments to the total revenue of HP. Meg Whitman has been saying that 2013 will be the year when the restoration will start, and the outlook of the company indicates that the CEO is right.
Having economies of scale and being the biggest vendor in the world is good. However, it can also hurt the company if the decline in revenue continues. At the moment, PC and printer segments are major cash flow contributors despite poor performance. As a result, these segments are extremely important to the company. However, HP will have to increase revenue from other segments to make for the loss in PC and Printer segments.
Bumpy Ride on the Way to Stability
Recent good news is encouraging. However, investors should not leave caution looking at HP. The company still has a long way to go. Patience will be a vital element for HP shareholders as I believe the strong base of its assets will help the company stabilize. Another important factor for HP is its strong cash position. The company reported $12.5 billion in cash and cash equivalents and generated $2.6 billion in cash flows from operations, a 115% increase from the last year.
Furthermore, free cash flows are incredibly strong for the company. HP has been paying dividends despite its troubles. For the last quarter, dividend payments stood at $511 million. If HP is able to maintain or increase free cash flow growth over the next year, net debt of the company will come down, allowing it to increase dividend payments. The company has targeted $5 billion in free cash flows for the full year. However, $2.1 billion in free cash flows generated during the first quarter indicates that the company will be able to generate more than the guidance.
HP is a work in progress and by no means it's close to a finished product. There is still a long way for the company to go before it can gain previous heights. However, I believe the company is on the right track, and it will eventually come out of its troubles. HP shareholders should keep in mind that it will not be an easy ride - there will be a lot of ups and downs on the way. I believe management has taken the difficult steps, and the company has been successful in bringing its house in order. The cost structure is now looking in line with the revenue stream, and operational efficiency has increased. Investment in HP has its risks. However, I believe it can give a big reward as well. I am confident about the long-term stability and growth of the company.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.