Hewlett-Packard - Bump In The Recovery Road Offers Buying Opportunity

| About: HP Inc. (HPQ)

Shares of Hewlett-Packard (HPQ) were selling off in after-hours trading on Wednesday. CEO Whitman's comment that the company is no longer expecting revenue growth in the next fiscal year is to blame as the path to a recovery is taking longer than expected.

The bump in the road to recovery might provide long term investors with an excellent entry point for the long haul.

Third Quarter Results

Hewlett-Packard generated third quarter revenues of $27.23 billion, down 8.2% compared to last year and down 1.3% compared to the second quarter. Adverse currency movements shares off 1 percent point of revenue growth. Revenues were roughly in line with consensus estimates of $27.3 billion.

The company reported GAAP earnings of $1.39 billion, or $0.71 per share, ahead of consensus estimates of $1.19 billion. This compared to second quarter earnings of $0.55 per share and last year's losses of $4.49 per share on the back of $9.2 billion in goodwill impairments.

GAAP earnings came in ahead of HP's own outlook of earnings of $0.56 to $0.59 per share, while non-GAAP earnings of $0.86 per share were in line with the previously issued outlook of $0.84-$0.87 per share.

CEO Meg Whitman commented on the third quarter performance, " I remain confident that we are making progress in our turnaround. We are already seeing significant improvement in our operations, we are successfully rebuilding our balance sheet, our cost structure is more closely aligned with our revenue and we have reignited innovation at HP, with a focus on the customer."

Looking Into The Results

HP saw revenues declines across all of its divisions, which was clearly disappointing. Personal systems revenues fell by 11% to $7.70 billion, but were up 1.5% compared to the previous quarter. Weakness was driven by poor consumer sales. Operating earnings almost halved to just $228 million, for an operating margin of 3.0%.

Printing revenues fell by 3.6% to $5.80 billion and were down on a sequential basis as well, after a strong second quarter. Operating earnings fell by 4.4% to $908 million, for fat operating margins of 15.6%.

The enterprise business, which was relatively solid before, reported a 9% decline in revenues to $6.78 billion. Operating earnings fell by almost 20%, putting pressure on margins which still came in at 15.2%. Weakness was driven by business critical systems and industry standard services.

Enterprise services revenues were down 9% to $5.84 billion, as operating margins fell t o3.3%. Weakness in application and business services was too blame.

A bright spot was the troubled software unit which reported a 1% increase in revenues to $982 million. Operating margins rose to 20.5% of total revenues.

HP managed to lower its cost of sales by 20 basis points to 76.9% of total revenues, while selling, general & administrative expenses rose by 55 basis points to 11.9% of total sales, which is disappointing. Excluding the impact of amortization charges, impairment charges and restructuring related expenses, actual operating earnings fell compared to last year.

And The Rest Of The Year

HP reiterates its full year non-GAAP earnings outlook for earnings between $3.53 and $3.57 per share.

GAAP earnings are seen between $2.67 and $2.71 per share, with the difference between GAAP and non-GAAP earnings being explained by amortization of intangible assets, restructuring charges and acquisition-related charges.

Based on non-GAAP earnings of $2.55 per share for the first nine months of the year, fourth quarter non-GAAP earnings are seen between $0.98 and $1.02 per share. This is in line with consensus estimates of $1.01 per share.

GAAP earnings are seen between $0.78 and $0.82 per share.


Hewlett-Packard ended its third quarter with $13.25 billion in cash and equivalents. Total debt stood at $24.75 billion, for a net debt position of around $11.5 billion.

Revenues for the first nine months of the year came in at $83.17 billion, down 8.0% on the year before. Net earnings came in at $3.70 billion. At this pace full year revenues could come in around $110 billion, while net earnings could come in around $5.2 billion.

Factoring in losses of around 13% following the releases, with shares exchanging hands at $22 per share, the market values HP at $42.5 billion. This values operating assets at 0.4 times annual revenues and 8 times annual earnings.

Hewlett-Packard pays a quarterly dividend of $0.15 per share, for an annual dividend yield of 2.6%.

Some Historical Perspective

The troubles at HP have been well documented in recent times. Shares have fallen form highs of $55 per share in 2010 to lows of $11 at the end of 2012, as the personal computer market's decline accelerated and the past acquisition strategy turned out to be a great failure.

Yet CEO Whitman has reacted fast and the first efforts of her turnaround strategy are clearly noticeable as the pace of declining revenues and earnings is slowing down. Shares did recover to highs around $27.50 in recent weeks and have seen a twenty percent correction ever since.

Between 2009 and 2012, HP managed to increase its annual revenues by 5% to $119.9 billion, although revenues will come in markedly below that for this fiscal year. After reporting a $12.6 billion loss last year, HP will return to profitability, although earnings will bet nowhere near recent peak earnings of $8.7 billion in 2010.

Investment Thesis

Under command of Whitman, which has been the new CEO for almost two years now, Hewlett-Packard has made a lot of progress, although this seems to be stalling in recent times. The prediction that revenues will grow for the next fiscal year, starting in a three months time, has been scrapped. Instead of expected revenue growth, she now called this prediction "unlikely".

The continued slump in personal computer sales is partially to blame as price competition from likes of Dell (NASDAQ:DELL) is increasing. On top of that comes a disappointing performance of the enterprise units at the moment.

The easiest cost cuts have already been made in Whitman's plan to reduce headcount by 29,000. Yet Whitman keep shuffling staff around making COO Bill Veghte the head of the enterprise group. Former head of the unit, Donatelli, will head the new unit which will focus on innovation and his deal-making expertise will be used to make future acquisitions. Ironically, acquisition in recent years have been hurting HP the most, especially the deal with UK-based Autonomy.

It is crucial to gain some footing in the smart phone, tablet and cloud-business, all areas which are rapidly growing but in which HP is missing presence.

Back in May of this year, I took a look at the prospects for the firm after HP presented its second quarter results. The turnaround continues to gain traction, but HP is just facing some bumps on the road as progress goes slower than expected, and maybe hoped.

The decline in revenues has slowed down to 8.2% on an annual basis, down from 10.1% on an annual basis in the second quarter. On a consecutive basis, revenues bell by 1.3% over the past quarter, compared to 2.7% in the second quarter.

Long term investors still have to wait for 2015 or 2016, before HP has "fired up all its cylinders". The business is stable, and the cost structure and financial position continue to improve. Now comes the difficult phase of actually growing the business again by innovation and organic growth to rejuvenate revenue growth.

Yet Whitman expects to see benefits from recent investment translating into real innovation. However, the weak enterprise spending, continued slump in the PC market and weaker European and Asian performance continues to be a drag.

For now the recent sell-off might give investors a fair level to step in, in anticipation of a further recovery in the coming three years. The road to recovery was never going to be smoothness, so for long term believers, this might be an interest entry opportunity.

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.