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  • HP grew revenues in its fiscal Q3, driven by double-digit growth in personal systems.
  • Printers and services continue to be challenged, but are improving profitability.
  • HP could be worth $47 if it can arrest the sales decline in these two segments.

In my previous articles on HP (NYSE:HPQ), I wrote that the company's turnaround was well under way and that HP was worth $38 under fairly conservative assumptions, an 18% upside from the then share price of $32. Post Q1 earnings, I raised my price target to $42 based on increased operational efficiencies that the company guided to during its earnings call. Since my original call on 5/21, HP stock has outperformed the market slightly, rising 6.67%, against a 5% increase in the S&P 500.

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Business Performance

HP reported earnings that reaffirmed my positive outlook on the stock. Overall, revenues grew 1% YoY for the third quarter and non-GAAP EPS grew 3%. Personal systems revenue grew 12% YoY, with operating margins expanding to 4%, well above my expectations. Total unit growth was 13%, suggesting that the death of the PC market is greatly exaggerated. Printing revenue was down 4% with a 18.4% operating margin. The revenue trend is in line with my model, while the margin is slightly higher by around 40 basis points. Enterprise group revenue grew 2% with a 14% operating margin - in this case, revenue growth was higher than my model (which forecasts a 2% decline), but operating margins were 50 bps lower. Enterprise services revenue was down 6% with a 4.1% operating margin. My revenue estimates were in line, but I was forecasting a lower margin of 3% for this business. Software revenue was down 5% with a 21.2% operating margin. I have revised my revenue expectations down for this segment, as I was forecasting 5% growth earlier. HPFS revenue was down 3% and delivered a margin of 9.2%, lower than my forecast of 11%. For FY14, HP estimates non-GAAP diluted net EPS to be in the range of $3.7 to $3.74, with the difference to GAAP EPS of $0.95 driven by restructuring expenses and amortization of intangible assets. The FY14 post-GAAP EPS outlook of $2.75-2.79 is slightly higher than my expected EPS estimate of $2.74.

Valuation updates and summary

The recovery in the personal systems business appears to have arrested the trend in sales decline for HP, though the printer division and enterprise services continue to struggle. The company has greatly improved its operational efficiency more than I expected, and if it can arrest the decline in these two divisions, shares could be worth as much as $47. The market has reacted tepidly to HP's earnings, but the stock remains a compelling value and a strong buy.

Source: Update: HP Remains On Track To Exceed My Price Target

Additional disclosure: I am short HP $18, $20 and $24 puts.

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