Hold Off On Hewlett-Packard Until The Turnaround Proves Itself

Dec.18.13 | About: HP Inc. (HPQ)

Hewlett-Packard (NYSE:HPQ), often called HP, is in the middle of a widespread turnaround that aims to revive the struggling tech giant from recent profitability woes. Additionally, executives are focused on several prospective emerging technologies such as 3D printing and cloud computing that seem like they could be very lucrative for HP with the right established market share and intellectual property foundations.

Business Strategy - Turnaround Analysis
CEO Meg Whitman is leading a turnaround of HP operations. Consequently, HPQ's stock price has nearly doubled since January 2013. Admittedly, that information alone does not hint at Whitman's success in her turnaround maneuvers. Short-term technical variables, artificially cheap debt and overall bullish market sentiment can push up a stock price significantly above what company fundamentals and likely future earnings warrant.

Turnaround elements include a heavy emphasis on debt reduction and a partnership with Salesforce (NYSE:CRM) to develop "private cloud" services. Associated risks include a tough competitive environment and slowing global demand for traditional services that play into HP's operational strengths.

As part of its attempts to restart on solid footing and offer investors superior returns on equity investments, HP has rolled out computer systems for businesses designed to incorporate several data-management and analytics functions such as network operations, storage, recovery, lots of fast flash memory and superior pattern recognition. This is a good move for HP since it decreases overall company reliance on waning PC sales and the mercy of open-source software that is not profitable for HP.

Investment in 3D Printing
3D printing is a technology that recently emerged as a possible game-changer in customized manufacturing and DIY product design. HPQ's investment in a complicated 3D printer for industrial-level design could detract from the current leaders in 3D printing, such as 3D Systems (NYSE:DDD) and Stratasys (NASDAQ:SSYS).

With the 3D printer investment underway HP plans to fully enter the 3D printing market in mid-2014. Given HP's technical core competencies, background and financial resources, company executives feel that investing in 3D printing technology improvements will set up HP as an industry leader with commanding market share.

Competitive Environment
External threats to HPQ's are the success of IBM's (NYSE:IBM) greater overall profitability and a profitability profile that puts IBM in a position to hit HPQ with market share takeover that HPQ may not be able to counter given its relative large-scale weakness compared to IBM. Additionally, the high devotion to cutting debt eats into short-term profits that might be better invested in other ventures, especially considering that the current low interest rate environment engineered by central banks is very unlikely to significantly change in the near future.

Financials Overview
FY 2012 saw a large drop in operating income and net margin. In HP's history as a public corporation, the only other time these variables were negative was in 2002. Even then, in the midst of the tech bubble burst and corresponding early 2000s recession, HP suffered negative income and margins about a tenth as large as what the company experienced in 2012.

Total operating expenses saw a steady and controlled increase up until FY 2012, when they increased by 82 percent compared to FY 2011 before returning to a more reasonable $21.99B in FY 2013 . Major competitors IBM and Dell (NASDAQ:DELL) did not go through such a similar expenses spike, giving them a substantial competitive advantage over HPQ. Total operating expenses as a percentage of total revenue give a rough estimate of operating efficiency for HPQ from FY 2010 until FY 2012.

Hewlett-Packard TOE/TR percentages for FY 2010-2012:

  • 2010: 17.00
  • 2011: 18.26
  • 2012: 35.25

HPQ's expenses spike and corresponding profit drop in FY 2012 stands out. This was caused by a focused restructuring effort that seeks to reverse waning company prospects in the last several years.

Summary
While a technology sector index fund or ETF may be a winning investment given a loose monetary policy and the low interest rate environment, HPQ in particular is not likely to deliver competitive returns in the next few years. Investors should temper "turnaround" hopes for with sobering mediocre demand for existing products and HP's prominent competition, specifically IBM and DELL. Having said that, there does not seem to be any significant operations snags, damaged brand reputation, excessive debt or any other hazards that can sink an established business. Therefore, overall, Hewlett Packard merits a "Hold" recommendation.

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.