The Ray Of Light For HP

Jun. 9.13 | About: HP Inc. (HPQ)

HP Equity research

A good amount of skepticism was observed when Meg Whitman took over as the CEO of Hewlett-Packard (NYSE:HPQ) specifically because of her plans around Enterprise services. This was a substantial portion of her turnaround plan that also included launch of new Moonshot servers and better relationship management with customers. Well, it turns out that these strategies worked out in favor of HP as reflected in its second quarter results. Though the company did not deliver outstanding results but it sure did exceed investors' expectations.

Remarkable Results: Check

HP's share price surged by 13% after the earnings release on the explanation that investors were expecting worse results. Revenue for the quarter declined by 10% as compared to the previous year, whereas net income excluding extraordinary items fell to 87 cents per share from 98 cents in the prior year. Earnings beat street estimate of 81 cents per share. The challenging state of affairs of PC market is no stranger to us and as such beating street estimates impressed investors who were expecting worse results.

HP's results were on the radar of most analysts as these results were to bear a testimony to Whitman's turnaround plans and could crown her as the best one to do the job. More precisely, I was really eager to hear about the performance of Enterprise services division because of a couple of reasons. Firstly, this was on the top of Whitman's turnaround plan along with entering the tablet market (discussed later in the article) and also, it was a risky territory requiring lot of work and appropriate guidance to compete against giants like IBM and Oracle.

To tell the truth I was pretty impressed with the performance of Enterprise Services Division that pulled off some big wins and achieved a margin of 2.6%. Even though revenue declined by 8% y-o-y, it was encouraging to see some big wins that should set the foundation for a robust recovery in this division. The printing division was among its best performing ones with net revenue of $6.1 billion for the quarter mainly riding on the success of Ink and Office products. The only area of concern with printing was a decline in lower end customer and a resultant reduction in revenues by 5%

Great Numbers: Check

Another highlight besides Enterprise Service division's stable performance was operating cash flow for the quarter. HP generated $3.6 billion of operating cash flow in the quarter, a 44% increase from the year earlier. This suggests that HP has developed financial discipline and adopted planned cost cutting initiatives during the period. In order to maintain investor confidence during troubled times, a company should make them believe that it is generating sufficient money and an increase of 44% in OCF definitely does that.

Dell Vs HP Battle

Sometime back, Dell (NASDAQ:DELL) made strong claims that it was taking away HP's market share in the server markets at a staggering rate. Dell claimed that it grew its server market share to 28 percent while HP's share declined from 35% to 31%. HP did not officially respond to such claims but analysts have observed that HP is more focused on long haul investments and as such passed on some deals that could have been achieved with effective pricing. Dell's buyout group led by billionaire investor Carl Icahn did not give any strong reaction to its poor Q1 earnings wherein company's profit dropped by a massive 79%.

Michael Dell's group has proposed an amount of $24.4 billion for taking the company private. The disastrous results for Q1 had a silver lining in the form of enterprise solutions, services and software business that was up by 12% to $5.5 billion.

Future analysis: Check

Truly speaking, HP is going through a complex transition and therefore minor bad news can also spur investors to sell the stock. The PC market has been on a steep decline since 2012 and because PCs comprise a sizable portion of HP's business portfolio, it poses an inherent risk to the company. In the points mentioned below I have tried to cover the details of what is happening at HP and what should investors be on the lookout for:

· A biggie is HP's entry into the tablet markets with HP Slate 7 plus the launch of Chromebook, a sleek PC device. This is the first time HP has shaken hands with Android and it will be interesting to see how this plays out given the intense competition and HP's late entry to the party.

· The launch of HP's Moonshot servers was quite successful and it seemed evident from the earnings call that the management is highly confident in these servers and negotiations with customers have already begun.

· Whitman has estimated laying off as many as 29,000 employees by the end of fiscal 2014 as a major cost cutting initiative. Since the company is now in the process of rekindling sales, major cost cutting initiatives should help sustain reasonable free cash flow.

The bottom line

Well, if one thing was highly visible after HP's earnings then it was the surge of 13% in its share price implying a boost in investors' confidence. My opinion is that when a company is in the middle of tough times it is investor's confidence that drives movements in company's share more than statistics. It is basically a test for the company because even a small aberration can spur investors to sell the stock.

Undoubtedly, Meg Whitman is doing her job well and giving company's long term interests a priority over short term gains that can be disastrous. It will make sense to have HP in your portfolio because it always had the required potential and now, it has a superb executive team that can optimize on that potential.

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.