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Shares of Hewlett-Packard (HPQ) have seen solid trading results following the release of its second quarter results on Wednesday after the close, marking the fact that shares have more than doubled since November of last year.

The results reveal that the turnaround at the company continues to gain traction, but the risk-reward is less favorable at the moment given the significant run up in the shares in 2013.

Second Quarter Results

Hewlett-Packard generated second quarter revenues of $27.58 billion, down 10.1% on the year before. Revenues fell by 2.7% on the previous quarter and fell short of consensus estimates of $28.12 billion.

Non-GAAP earnings fell 13% to $1.70 billion, but were actually up 6% compared to the previous first quarter. Non-GAAP earnings per share fell from $0.98 to $0.87 per share, but beat consensus estimates of $0.81 per share.

GAAP earnings fell by 32% on the year to $1.08 billion, and fell some 13% on the previous quarter. GAAP earnings per share fell from $0.80 to $0.55 per share, beating the company's own guidance.

CEO Meg Whitman commented on the developments and the report, "We beat the upper end of our non-GAAP diluted EPS outlook for the quarter by $0.05 per share, driven by better than expected performance in Enterprise Servicing and Printing, coupled with the accelerated capture of restructuring savings and improvement in our operations."

Taking A Deeper Look At The Results

The personal systems unit had a tough quarter, generating revenues of $7.58 billion, down 7.5% on the quarter and down 20.0% on the year as a continued slump in the personal computer segment had an impact. Operating profits more than halved to $239 million compared to last year, but actually increased by 7% compared to the previous quarter.

Solid was the performance of the printer division which generated revenues of $6.08 billion. Revenues were down by merely 0.8% on the year, but were up 2.6% on the quarter. Operating income advanced by 0.5% on the quarter to $958 million and is up 19% on the year.

The enterprise group reported a 9.6% decline in revenues which came in at $6.82 billion. Despite a 2.4% fall in revenues compared to the first quarter, operating income essentially came in unchanged at $1.08 billion. Operating profits fell some 20% on the year.

Enterprise services revenues fell 7.5% on the year to $6.00 billion, but increased by 1.3% on the quarter. Profitability of the business remains a severe issue. Earnings fell by 34% on the year to just $156 million, but operating earnings more than doubled from the last quarter.

The troubled software unit continues to fail in its attempts to grow revenues. Revenues fell 3% on the year to $941 million, but were up 1.6% on the quarter. Cost cutting measures improved profits as operating earnings rose 5% on the year, and were up even 15% on the quarter to $180 million.

Looking Ahead For The Remainder Of The Year

For its current third quarter, Hewlett-Packard estimates non-GAAP earnings to come in between $0.84 and $0.87 per share. GAAP earnings are expected to come in between $0.56 and $0.59 per share, resulting in continuing stabilization and improvement of GAAP earnings in recent periods. On average, analysts were looking for a guidance of non-GAAP earnings of $0.84 per share.

Hewlett-Packard raised the low end of its previously issued full year outlook by 10 cents. The company sees non-GAAP earnings coming in between $3.50 and $3.60 per share, with diluted earnings per share coming in a dollar lower. Investors and analysts are comforted by the reiteration of the full year guidance, as consensus estimates for full year non-GAAP earnings stood at $3.49 per share.

Valuation

HP ended its second quarter with $13.2 billion in cash and equivalents. The company operates with $26.8 billion in short and long term debt, for a net debt position of $13.6 billion. Driven by a solid $3.6 billion in positive operational cash flows during the quarter, HP managed to reduce its net debt position by $1.8 billion.

Last year, HP generated annual revenues of $120.4 billion, down 5.3% on the year before. Driven by large one-time charges, mostly related to the poor acquisition of Autonomy, the company reported a $12.6 billion loss compared to a $7.1 billion profit in the year before.

Factoring in the gains following Thursday's trading session, the market values HP at $47.4 billion. This values the company around 0.4 times last year's revenues and 9-10 times this year's projected annual earnings.

HP recently hiked its quarterly dividend to $0.1452 per share, for an annual dividend yield 2.2%.

Some Historical Perspective

Long term holders of HP's stock are still suffering from the long term demise of the company, even as shares recovered recently amidst the first promising signs of the turnaround led by Whitman.

Shares of the company peaked in their mid-fifties in both 2007 and 2010 to fall to lows of $11 back in 2012, as the personal computer industry continues to shrink and HP suffered from the financial implications from the failed acquisition strategy.

In the past six months alone, shares have more than doubled following the promising results at the start of this year.

Investment Thesis

Investors are more than happy with the latest report, and the fact that the company remains on track to achieve its full year targets. The company is making track to restore its balance sheet, and even has some cash left over to please shareholders. At the same time, revenues continue to be under pressure, as the company prioritizes profits over revenues at the moment, thereby boosting cash flow generation.

As CEO Whitman warned that the turnaround story is a multi-year journey, and it could take HP until 2015 or even 2016 before it could "fire up its cylinders", investors are happy with the quick and substantial progress already being made. After repurchasing worth almost $800 million of its own shares over the past quarter, the company is repurchasing its shares at a pace of 7% per annum, indicating the company thinks it is undervalued.

Important as well is the $9 billion net debt reduction over the past year, as the company hopes to reduce its net debt position towards zero at the end of the year. Recently the company hiked its quarterly dividend as a sign of confidence.

Underlying the profit stabilization amidst the poor revenue developments are steep cost cuts. As the company is suffering from a though personal computer market, HP reported a 20% fall in revenues driven by the continued slump and difficult comparable period last year. As HP lacked a presence in the tablet market, the enthusiasm about the prospects of its "Slate" mobile device is an encouraging sign.

Back in February when the company reported its first quarter results I took a look at HP's prospects. I concluded that HP's turnaround was gaining traction, despite the continued slump in Personal Computer sales as the operations in other divisions are stabilizing, notably the printing business was very strong in the past quarter.

Most important is that Whitman has stabilized the business. HP is rapidly repairing its balance sheet, its operations and profitability. At the moment, I reiterate my conclusion reached in February. For investors with a higher risk tolerance, HP represents a solid investment opportunity.

In the meantime shares have risen some 40% from $17 in February to current levels around $24 per share, on the back of a solid market sentiment as well as positive news about the turnaround.

While HP has many challenges ahead in the long run, the progress so far is remarkable and solid. While I still like the risk-reward ratio at these levels, I am less enthusiastic at the moment after the significant run up in recent months.

Source: Hewlett-Packard: Shares Rally Hard As The Turnaround Continues To Gain Traction