Hewlett-Packard: Time To Rebuild

Mar.28.13 | About: HP Inc. (HPQ)

Hewlett-Packard (NYSE:HPQ) did not have a good year in 2012.

After three years of booking net income between $7 billion and $9 billion, HP suffered an annual loss of $12.65 billion in 2012. The loss was caused by the incurring of after tax costs of $20.7 billion, or $10.46 per diluted share, related to the impairment of goodwill and purchased intangible assets, restructuring charges, amortization of purchased intangible assets, charges relating to the wind down of non-strategic businesses and acquisition-related charges.

The problems go back before last year. In the last two years, HP has written off more than $17 billion to account for three acquisitions that didn't turn out so well: technology consulting service EDS, device maker Palm and business software maker Autonomy.

In the case of Autonomy, HP said it uncovered accounting irregularities that increased the acquisition price by at least $5 billion. An investigation led HP to conclude that Autonomy was substantially overvalued at the time of its acquisition due to the misstatement of Autonomy's financial performance, including its revenue, core growth rate and gross margins, and the misrepresentation of its business mix. HP took an impairment charge of $8.8 billion during its fiscal fourth quarter, contributing to the massive loss.

Back on Track

The company appears to be on the right track following its fiscal first quarter earnings announcement in February. Earnings per share totaled $0.82, down 11% from the prior year but above the company's previous outlook of $0.68. First-quarter net revenue was $28.4 billion, down 6% year over year. The company booked cash flow from operations of $2.6 billion, up 115% from the prior year, while it returned $511 million in cash to shareholders in the form of dividends and share repurchases. The company improved its net debt position for the fourth consecutive quarter by over $1 billion.

For its fiscal second quarter, HP estimates earnings per share will be in the range of $0.80 to $0.82, and between $3.40 and $3.60 for the full year.

HP shares hit a 52-week high of $25.40 in early May 2012. That began a steady decline in value over the next several months, as shares bottomed out to a 10-year low of $11.35 in November. That was the beginning of a steady upward trend, as the stock price is now around $23, more than double from that low.

However, HP shares are still down about 7% from a year ago, and off more than 55% from three years ago.

The company raised its dividend to 14.52 cents from 13.2 cents, which currently yields 2.3%.

The company grew its cash position from $8 billion at the end of 2011 to $11.3 billion last year. Its debt totals $28.23 billion and outweighs its equity. Its liquidity ratio is low, with a quick ratio of 0.70 and a current ratio of 1.10.

Decline in PC Business

In addition to the recent writedowns, HP has also had to overcome the continuing decline in personal computer sales. Half of HP's revenue comes from two divisions, personal computers and printers, both of which are in long-term decline. That's why Hewlett-Packard has been trying to change from a hardware company to a software and services company for some time. Yet as it makes that transition, the company faces stiff competition from the likes of IBM (NYSE:IBM), Oracle (NYSE:ORCL) and SAP (NYSE:SAP).

HP Enterprise Management & Analytics recently rolled out a service specially targeted at its enterprise clients intended to manage and evaluate data. This is a new line of business for HP, which will help it generate additional revenue, as it has the potential to improve efficiency, reduce risk and lower the cost structure of customers.

HP still isn't done in the hardware and computer sectors. The company recently launched the Pavilion 14, its first Chromebook, which are lightweight laptops that run on Google's Chrome operating system. Chromebooks have become very popular because of their low price in the struggling economy.

Analysts are Somewhat Pessimistic

Analyst opinion is tepid at best. Twenty-four of 34 analysts rate the stock as a hold, while eight others have it rated as an underperform or sell. Following the company's quarterly conference call, some analysts had this to say about the company:

"Dynamics in PCs are expected to get tougher, enterprise services are experiencing weaker bookings, and printing continues to experience secular headwinds," said Abhey Lamba of Mizuho Securities. "We reiterate our underperform rating as we expect the company to remain strategically challenged in the near term."

"The bad news is that all business segments declined and will likely continue to see pressure through FY13," said Shaw Wu of Sterne Agee. "Some may be disappointed that the company commented that it has no plans to break up its businesses as some have called for. While the feel-good sentiment will likely continue, we see limited upside from these levels."

"Our view remains unchanged, we believe the challenges across HP's portfolio and massive downsizing initiatives during this critical transition period in the IT market will leave HP less relevant over the next 12-18 months," said Brian White of Topeka Capital Markets. "As such, we remain sellers of HP on any strength this morning."

"While we still prefer that HP divest the PC business, we also acknowledge that HP's model appears to be recovering even as PC revenue and operating profits deteriorate," said Mark Moskowitz of JPMorgan.

After its rough 2012, this year is a rebuilding one for HP. Meg Whitman, HP's CEO, recently stated that the company will see a revenue growth in 2014. She said that the new restructuring strategy will pay off in 2014, which means that the company won't see any revenue acceleration in 2013.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: This article was written by an analyst at Catalyst Investments.