Hewlett-Packard (HPQ), one of the leading players in the PC market, can breathe a sigh of relief after a modest fall in the declining rate of worldwide PC shipments. As per IDC's third quarter report, PC sales declined by 7.6% year over year in the third quarter of 2013, slightly better than the IDC's original projection of 9.5% year over year. This reduction in the decline rate was due to a rise in commercial PC shipments.
HP posted a modest 0.4% year over year growth in the shipments, but the biggest positive fact was that the U.S. shipments posted bigger growth than worldwide shipments. HP is the biggest player in the U.S. PC market. With 27% market share and with shipment growth of 3.5% year over year in U.S., this recovery is a positive sign for the company. The U.S. market declined 0.2% year over year, as compared to the 1.9% year over year decline in the second quarter, which indicates a sign of improvement.
HP is in a restructuring phase under the leadership of its CEO Meg Whitman. In its latest Securities Analyst Meeting, the company provided a positive forecast for the future due to its strategic initiatives. In our last report, we discussed HP's massive layoff program, which is expected to provide substantial cost savings.
Securities Analyst Meeting bring bright prospects for investors
On October 9, 2013, HP conducted its Securities Analyst Meeting, where the company disclosed its revenue guidance and status of its turnaround initiatives. The company seems well on track to achieve its five year revival goal in which the company will become leader in the key business areas. The numbers provided by the company were bullish, with revenue decline to be at a more moderate rate than in the current fiscal year.
The most important investor's takeaway is that the company will return 50% of its expected free cash flow in fiscal year 2014 via dividends and share repurchase. Another key topic in the meeting was that HP has reduced its debt by $8 billion in the last 12 months, thus reaching debt level of $1.2 billion at the end of the third quarter of 2013. This debt level was below the range when HP acquired Autonomy. The company wrote off $8.8 billion of value of its acquired Autonomy last year, which adversely impacted the company's balance sheet. HP is expecting to reach zero debt by the end of the first half of next fiscal year.
HP set an annual target of reducing 29,000 positions last year, with a plus and minus range of 15%. The company is expected to reach the target of 24,000 positions by the current year's end, and as per the forecast, HP will end its job reduction target in the higher range with an extra 15%, or 4,350 positions, by the end of fiscal year 2014. Therefore, this excess savings in employee cost will help the company improve its operating margin and devote more of its savings as investment in the business.
We believe HP has laid a foundation for its target of becoming an industry leader in the key areas by 2016. Reaching zero debt and reducing its cost base will help improve the company's bottom line. This is important as the company is suffering from decline in the top line; therefore, cost management is an important move for net profit growth.
Continued focus towards "New style of IT"
HP has mentioned its strategy of providing solutions for areas that will help in long term growth. These areas are regarded as the new style of IT, where the company is trying to mobilize its resources for effective transition from its old style. The following are the areas that the company has prioritized in each of its four segments i.e. Enterprise Group, or EG, Software Business, or SW, Enterprise services business, or ES, and Personal and Printer Systems business, or PPS:
These areas are the fastest growing under the four segments of the company. Targeting these will prove to be important revenue generation sources in the long run. We believe that this "New style of IT" looks to be a perfect strategic initiative, but the key part will remain execution. Looking at the current status of the company's turnaround initiative, HP is expected to execute these initiatives in the targeted time space.
EG has been an area of concern for HP with segments' incremental non-GAAP EPS contribution for the fiscal year 2014 versus fiscal year 2013 expected to be in the range of ($0.01)- $0.02. Therefore, to boost the company's revenue growth in the $221 billion enterprise group market, HP is focusing on transition to converged infrastructure and converged cloud solution, which are part of the new IT product initiative. Both the converged infrastructure and cloud elements are areas where HP is expecting a growth opportunity. HP is implementing a go-to-market strategy, which includes detailed market segmentation and product alignment towards region specific demand. Therefore, providing a region centric customized product will help increase the customer value. The following is the EG strategy as its moves to the "New style of IT".
HP's current plans aim at forming Cloud driven enterprise group to provide complete and optimized solutions including servers, storage, networking, and attached technology services. By providing a complete solution, HP's cloud services will add value to its enterprise customers. The company had 1900 enterprise customers in the HP cloud business as of the third quarter 2013, a 60% year-over-year growth. In addition to this, 37% of Fortune 100 companies are deploying HP converged cloud, which indicates good penetration in the big companies.
Rise of competitor from PC to enterprise market
HP, which has dominated the PC market in the U.S., is facing growing competition from its American counterpart Dell (DELL), which currently stands second in the U.S. PC shipments and third worldwide. Dell showed its first positive year over year growth since the fourth quarter of 2011 in the world PC shipments, with 0.3% year over year growth in third quarter of this year. This growth was contributed by the improvement from the domestic U.S. market, where the company posted 2.3% year over year growth. Dell is on the verge of becoming private. Its founder Michael Dell, in partnership investment firm Silver Lake Partners, will acquire the public shares for $24.9 billion. This transaction is aimed at reviving the company fortunes. The company will benefit from speedy strategy execution due to lower scrutiny and disclosures than a public company.
The competition to HP from Dell in the PC market has now extended to enterprise business. Dell has realized the importance of extending its footprint in the enterprise solution, which will offset the negative impact of the falling PC market. Dell has strong channel partners like Oracle (ORCL), which has helped the company expand its enterprise business. This hardware plus software (Oracle) combination added another element to Oracle's partnership with Dell, announcing integration of Oracle management software, or Enterprise Manager 12c, with Dell solution. Earlier, there were two consoles required, one for managing installed Oracle database software, and one for managing Dell hardware via its own OpenManage software. Now, integration of OpenManage and Enterprise Manager 12c will increase the user experience with one console for Oracle Enterprise Manager Console software. This will maximize performance, achieve operational effectiveness, and improve resource optimization. Dell has also launched an Active infrastructure for the Oracle operating system and Oracle Virtual Machine. This is a converged infrastructure, which gives a complete packaged solution to data centers with one machine.
This partnership will help Dell expand its customer base with Oracle enterprise users, thus increasing its footprint in the enterprise business. Oracle, on the other hand, will benefit from Dell's strong hardware expertise in providing value to its customers.
Announcements made at the securities analyst meeting created a positive vibe in the market. With the PC market decline rate reducing in the third quarter, HP is on track for revival. The company hasn't made any specific announcement regarding ending its merger and acquisition drought, which has been a negative aspect of the whole meeting. The next fiscal is a vital year, which will prove as an inflection point for the company's profit and cash flow growth.
All the projections made by HP look positive, but the GDP like growth rate in 2016 and no clear cut capital allocation apart from shareholder return might create doubt among investors regarding HP as an investment. In addition to this, HP has yet to make a considerable presence in the growing tablet market, which has been a problem for its personal systems business.
Therefore, after analyzing all the pros and cons, we are upgrading HP to a buy rating from the earlier hold. We support the company's initiatives and projections, and we believe the company has set an important growth strategy that will help it shine in the Silicon Valley.