Hewlett Packard (HPQ) reported earnings after the close today, May 22nd. The report sent shares soaring as much as 13% higher in after hours trading. On the face of it, this appears to be a rally driven by the concept that earnings were not as bad as they could have been. Because, there certainly is not much related to this earnings report that says HPQ has turned a corner and has a clear path to reinvigorating its business. On the contrary, revenue for every single reportable segment was down on a YoY basis. While earnings can be massaged through share buybacks and cost cuts until this company can begin to show revenue growth again, the risk will continue to be to the downside. HPQ is currently trading at levels, if they hold into the open of trading Thursday, it will mark a 52 week high for this company. I highly recommend any holders of HPQ to use the spike Thursday to either exit the stock completely, or at the very least sell out of the money call options, to take advantage of the jump
The Wild Ride For HPQ In 2013
The stock of HPQ has been on a tear over the last 6 months. Since bottoming in November 2012, at under $12 per share, the stock is up nearly 100% to $24 a share: The rise has been pretty meteoric as the chart will show:
There has not been a singular catalyst that one can point to as to why the stock has seen its dramatic rise. HPQ was never an imminent bankruptcy risk, and arguably should not have traded at under $12 per share. At the same time, the news flow recently with regards to the IT industry has been mostly bearish. International Business Machine (IBM), significantly underperformed with its latest quarterly earnings. Personal computer shipments saw their biggest quarterly decline ever. Two reasons stand out as to why HPQ has risen so much this year. The first is simply the dogs of the market have seen a bid in 2013, and HPQ was the dog of the Dow in 2012. The second reason that gets bantered about quite often is that the break-up value of HPQ could be close to $30 per share, according to at least one analyst. This is an interesting argument as HPQ carries a significant debt load, and the business segments that would be broken up all have seen significant declines in their top line performance.
The company reported Q2 FY2013 revenue of $27.6B, which was down 10% from the prior year. Across the business segments, Personal Systems which makes up close to 28% of total revenue, saw the largest YoY decline at almost 20%. This segment consists of personal computers mainly. It is hard to see the outlook for this segment halting its rapid decline any time soon, considering the lack of a meaningful presence HPQ has in the tablet market. The Printing segment makes up another meaningful portion of total revenue for HPQ, at 22% of the total revenue for the company this quarter. This segment only saw a 1% YoY decline. However, this is another segment that is facing secular challenges, with other companies such as Lexmark (LXK) essentially preparing to exit portions of the printing business altogether. All told, close to 50% of revenue this quarter for HPQ was tied to Personal Systems and Printing. It is hard to see a viable plan to halt the decline of these business segments as the headwinds are secular in nature.
The apparent positive reaction to the earnings is that the company maintained it's guidance for FY 2013, slightly bumping up the low end of the range. Guidance on a GAAP basis for 2013 was reiterated at a range of $3.50 to $3.60.
Another big story for HPQ surrounds the balance sheet, and the question surrounding the company's ability to continue to generate meaningful cash flow. The company generated $3.6B in cash from operations, which was 44% higher on a YoY basis. The company also lowered its outstanding debt balance. Lastly, the company continued to take shareholder friendly actions by repurchasing almost $800M worth of shares in addition to increasing the quarterly dividend by 10%.
From a balance sheet standpoint, the story is a little brighter than the headwinds facing the sales side of the business.
How To Trade The Earnings
As noted earlier, HPQ should open at a 52 week high Thursday based on the after hours action Wednesday. I think there is defined ceiling in this stock, around $30 per share, which is where at least one analyst pegged the break-up value of HPQ. In the same vein, the consensus target for HPQ per analyst estimates at Yahoo! Finance, is only $20 per share. You can expect that there will be some downgrades based on valuation as nothing in this report will change the overall outlook for those analysts who are bearish on the stock.
I highly recommend that investors use the pop in the shares Thursday to lock in gains. If you are committed to owning HPQ, then at the very least sell call options against your stock, as volatility will be smoking in the morning if the stock opens up double digits.