Hewlett-Packard Remains An Attractive Investment

| About: HP Inc. (HPQ)

Summary

Hewlett-Packard reported slightly disappointing results for the second quarter of FY 2014.

Hewlett-Packard aims to reduce its workforce by almost 15% in order to attain operational efficiency.

The company had been generous towards its shareholders, and has continued rewarding them through dividends and buybacks.

This stock is no longer a growth story, but is still an attractive investment for income investors.

Hewlett-Packard Company (NYSE:HPQ) has been suffering from the declining use of the technology it excels at creating. But it is something considered as a norm in the technological sector that every technology sooner or later meets obsolescence. Unfortunately, Hewlett-Packard has not been able to find or create new and outstanding technology that can bring back the days of glory for the company. This article will analyze the company's recent quarterly performance to derive a justified conclusion for investors.

Financial Performance

Hewlett-Packard Company reported its results for the second quarter of fiscal year 2014, revealing a mixed picture of the company's performance during the quarter. The company missed analysts' expectations by $110 million in terms of revenues, but managed to report EPS in line with the consensus estimates of analysts. It earned an EPS of $0.88 on revenues of $27.3 billion. Revenues for the quarter fell 1% year-over-year, and were flat on a constant currency basis.

Segregating the company's performance by segment shows that Hewlett-Packard generates 94% of its revenues from its 4 segments: Printing, Personal Systems, Enterprise Group, and Enterprise Services, while the remaining 6% of revenues are attributable to the Software and HP Financial Services business units.

Source: HPQ Presentation

Out of the six segments that make up the company's business portfolio, the Personal Systems business was the only one with a year-over-year rise in revenues. The rest of the segments met year-over-year declines in revenues. Personal Systems' revenue increased 7% year-over-year thanks to the rising demand for PCs in the commercial sector (12%), which negated the deteriorating demand in the consumer sector (-2%). The company sold 10% more units during the quarter.

The Printing, Enterprise Group, and Software business units reported overall negative results, but digging deeper into the segments results showed a mix of positive and negative aspects.

Printing revenues declined 4% at the outset because of the 6% decline in supply revenues that offset the 1% rise in total hardware units sold during the quarter. Supplies revenues make up the 66% of total revenues of the Printing business, which therefore overshadowed the positive performance of the 44% contribution from hardware units.

The Enterprise Group segment met with a 2% decline in revenues year-over-year, despite the 1% rise in revenues from industry standard servers that makes up 43% of the segment's total revenues. This was because the revenues from rest of the parts of the segment declined heavily; storage revenues were down 6%, while BCS revenues deteriorated 14% year-over-year. It seems that the performance of the Enterprise Group segment is severely affected by the competitive environment in the cloud storage and server storage market.

The Software segment of the company reported flat performance year-over-year, despite the fact that revenues from licenses and services were up 8% and 3%, respectively. Fifty-one percent of the revenues of the Software segment are attributable to its support business that reported a 4% decline in revenues year-over-year, shadowing the segment's overall performance.

The Enterprise Services segment of the company reported a 7% year-over-year decline in revenues, because revenues generated from ITO and ABS reported disappointing results during the quarter. Their revenues were down 7% and 8% respectively, compared to the same quarter last year.

In spite of the revenue decline, the company managed to report EPS incorporating a 1% rise year-over-year. This is indicative of the company's operational effectiveness. Moreover, the company's total operating margin also remained intact, as it was flat year-over-year and incorporated a rise of 10 basis points quarter-over-quarter. However, the story differs for each of the company's segments. The Software segment experienced a heavy decline of 14.4 basis points in its operating margin quarter-over-quarter. The Enterprise System and Enterprise Services businesses also saw meager declines in their margins year-over-year, as well as quarter-over-quarter.

Hewlett-Packard has demonstrated its aim to grow its organization and become more operationally efficient, and for this purpose, it has decided to lay off 15% of its workforce. In 2012, the company had announced it would cut the jobs of almost 34,000 employees, which is equal to 10% of the workforce. Now the company has increased its target to another 16,000 job cuts, bringing the total to 50,000 job cuts.

Source: HPQ Data Tables

Future Outlook

For the second quarter of fiscal year 2014, Hewlett-Packard is expecting to earn an EPS of $0.86-$0.90, that on average, is in line with the second fiscal quarter's EPS. Hewlett-Packard has projected its EPS for FY 2014 to be in the range of $3.65-$3.76, while analysts estimate an EPS of $3.71. For fiscal year 2015, analysts estimate the company's EPS will reach $3.84. If the company earns an EPS of $0.88 in the 3rd quarter of FY 2014, the EPS of all three quarters of the year will equal $2.66. In order to achieve the EPS target of $3.71, the company will have to earn an EPS of $1.05 in the fourth fiscal quarter, and that seems difficult. The EPS targets are neither in line with the company's year-to-date EPS performance nor with the projections for the third quarter of FY 2014.

Stock Valuation

Hewlett-Packard has been consistently and generously rewarding its shareholders, despite the declining trend of its top and bottom lines. It recently declared quarterly dividends of $0.16 per share, reflecting a 10.2% increase from the previous dividend of $0.15. Its dividend growth rate over 5 years was three times the industrial norm. The company has already spent a heavy amount buying back its own shares, providing a reason for the EPS to grow.

In order to determine a fair value for this stock, I used the multiples-based valuation model, which revealed astonishing results. The model provided a fair value of $48 and an upward price potential of 52%. This may be because the stock is trading at steep low valuations in terms of its price multiples compared to the industry benchmarks. Therefore, the company's stock price may reach the industry levels, and that will allow it to grow significantly.

Concluding Remarks

Unfortunately, the company is trying to survive in a competitive environment at the cost of economic growth that will be hit due to such a massive job cut. Undoubtedly, the company's CEO has been putting serious efforts into repeating HP's past performance. However, how long can a company remain profitable on the basis of cost efficiencies? Eventually, cost reductions would end, and what would be the next option for the company to survive or remain profitable? Nothing but innovative technology or a new product portfolio can revolutionize the company and put its products in high demand to help it survive in the long run. Therefore, this analysis guides me to the conclusion that while Hewlett-Packard is no longer a growth story, it remains an attractive investment for income investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by a Gemstone Equity Research research analyst. Gemstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Gemstone Equity Research has no business relationship with any company whose stock is mentioned in this article.