- Hewlett-Packard reported generally in-line results, sending shares down over 2% as investors took profits after a solid one-year performance.
- Printing revenue was disappointing, though units shipped and profits were strong while commercial demand has boosted the PC unit.
- HP's enterprise and software business are a mixed bag, and HP is cutting more employees to boost operating margins.
- HP is generating a lot of cash and should trade at least 10x earnings, which would push shares to $37.
On Thursday afternoon, Hewlett-Packard (NYSE:HPQ) mistakenly reported its quarterly earnings prior to the market's close. As a consequence, investors reacted to the headline results during the session, and shares fell 2.3%. CEO Meg Whitman has done a good job rebuilding investor confidence with shares jumping over 27% the past year. This quarter was relatively in line, and it seems like some investors took the opportunity to take some profits. Still, this quarter reaffirms two themes: HP's business is stabilizing and it has dramatically cut costs. Shares are attractively valued, and after these numbers, I think HP has further upside.
In its fiscal second quarter, HP earned $0.88 on revenue of $27.3 billion while analysts were looking for $0.88 on $27.41 billion (all financial and operating data available here). Revenue was down 1% year over year, and on a constant currency basis, it was flat. This is further evidence that HP has stabilized its business, but it is not yet growing the business. However with some market share gains in PCs and a solid economy, I do believe HP can deliver mild revenue growth in 6-9 months.
Printing was the major reason for the revenue miss as revenue dropped 4% to $5.8 billion. However, EBIT increased to $1.14 billion from $970 million last year. Thanks to headcount reductions and other efficiency measures, HP was able to earn more money despite generating less revenue. Supply revenue fell 6%, which reflects weak product sales in previous quarters. In this quarter, it sold 1% more units with commercial orders up 3%. Higher printer sales in this quarter should translate to better product sales in coming quarters. While revenue missed, printer sales were decent, and a 19.5% operating margin was better than I was looking for.
There is also further evidence that the PC isn't dead. PC revenue jumped 7%, and operating margins were a solid 3.5%. Units sold were up 10%, which means average selling price continues to fall, which has been a long-term trend for this unit. In PC sales, we are seeing a bifurcation with commercial revenue up 12% while consumer fell 2%. While tablets have kept some consumers from buying PCs, enterprise has been far stickier. HP is also picking up share in enterprise. After its LBO, Dell is saddled with debt, allowing HP to discount its PCs to a price where Dell struggles to compete and take market share, which can have the halo effect of increased printing and service revenue in coming quarters. HP's PC unit has stabilized with enterprise showing a bit of growth.
In HP's enterprise units, there was a mixed bag. Service revenue fell 7% while hardware revenue dropped 2%, compared to a 1% gain last quarter. Storage remains a very competitive business, pushing revenue down 6%. On the positive side, HP's networking revenue did jump 6%, which offset some of the weakness elsewhere. Software revenue came in flat, which was better than last quarter's 4% drop. Licenses jumped 8%, which should help software revenue in future quarters. Overall, these enterprise units reported mixed results as HP deals with fierce competition from cloud firms and other legacy IT companies like Cisco (NASDAQ:CSCO) and IBM (NYSE:IBM).
Overall, the theme at HP is still stabilization. To grow profits with revenue flat, HP is looking to cut more costs and will lay-off up to 16,000 employees. This cut comes on top of a 2012 program that trimmed 34,000 jobs. These efforts will help HPQ grow profits faster than revenue. Importantly, HP is still investing in R&D with spending rising 7% in the quarter. R&D is necessary to develop projects that will grow revenue in future quarters and years, and cutting this spending will endanger the long-term potential of the company.
Finally, HPQ continues to be a cash machine, generating $3 billion in operating cash flow and about $2.3 billion in free cash flow. HP used this cash flow to buy back $831 million in stock and pay its dividend, which costs $298 million per quarter. For the ninth straight quarter, HP's net cash position increased by at least $1 billion. Total cash now sits at $15.1 billion. For the full year, HP still expects to earn $3.65-$3.76 while analysts are looking for $3.71. With strong cash flow, buybacks, and a stabilizing business, shares are very cheap at 8.5x earnings. Still with its lack of revenue growth and weakness at the enterprise unit, HPQ should trade at a discount to the market. Even at a conservative 10x earnings, shares could reach $37. At current prices, HP has upwards of 20% upside and is a buy here.
Disclosure: I am long CSCO. 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.