Weak second quarter earnings from Hewlett-Packard (HPQ) is a reminder for investors that the promised day for a revival in PC sales is not here yet, and may be gone forever. HP shares reached all-time lows last week, closing at a recent price of $17.58. Shares now pay a yield of 3%. A weak global economy, declining demand for PC's, and competition from tablets are some of the many factors hurting HP. HP is clearly a company in transition. Should investors wait-and-see for HP to turn-around, or look for other opportunities?
A summary of HP's 3rd quarter results is below.
- Non-GAAP diluted EPS of $1.00 per share, beating the $0.94 to $0.97 estimate given in May
- GAAP EPS loss of $4.49 per share
- $29.7 billion revenue
- $2.8 billion in operating cash flow
- $2.1 billion in free cash flow
- Debt reduced by more than $1.5 billion
- Non-GAAP gross margins of 23.4%
- $9.9 billion in cash
- $8 billion write-down in goodwill in Services
- 3Par business grew over 60%
- Software revenue up 18% to $973 million
- Networking revenue up 6% to $647 million
- Server market weak
- PC revenue dropped 10% year-over-year with an operating margin of 4.7%
- Weakness in traditionally growing markets, including China (down 6%), EMEA (down 4%), and Asia Pacific (down 7%)
- 17% decline in printer unit shipment volume
- Consumer printer revenue down 13%
HP integrated its PSG and IPG units to reduce costs. During the quarter, staff was reduced by 4,000. For the fiscal year, HP targets a reduction of 11,500 employees, up from 9,000. HP is in a multi-year-transition. The company recognizes the industry is growing elsewhere: in cloud computing, mobility, and virtualization. HP is still reducing its own costs, limiting its ability to grow substantively in these markets.
HP expects to earn between $4.05 and $4.07 per share non-GAAP, or a loss of $2.23 to $2.25 per share using GAAP.
HP is responding to competitive pressure in 3 ways: First, HP is an effective product line-up at the corporate level. HP wants Ultrabooks and Windows 8 tablets for the corporate market to help improve results.
Second, HP views tablets for consumers is instrumental in growing profits.
Third, HP is reducing its cost structures. The company recently merged its Imaging and Printing Group ("IPG") with its Personal Systems Group ("PSG"). Reducing headcount will help the company generate better gross margins.
HP is following a similar path to that taken by Cisco Systems (CSCO). Cisco drastically reduced its workforce in response to growing competitive pressures. After reporting stronger sales and profits, Cisco's shares are now up 30.4% from its 52-week low. In contrast, HP has a long way to go. During Q3, HP grew its networking revenue during the quarter, but the segment was a very small part of the company's business.
Growing macroeconomic pressures in Europe and in Asia during the quarter hurt HP's efforts in reducing its channel inventory. Inventory growth was especially poor on the consumer segment, but HP is reducing its cost base to offset the weak pricing environment.
HP took a substantive $8 billion write-down in goodwill in its Services unit. Whitman associated the write-down at EDS with the problems of accountability currently being diffused across the organization. HP wants its leaders have control of costs relative to revenue. EDS will also be shifting away from lower-margin services, and towards cloud and security services.
HP's chief competitors are Dell (DELL) and Apple (AAPL). When Dell reported earnings, the company earned $0.42 per share. Dell saw growth in its server, services, and networking businesses. Like HP, Dell is transforming itself by growing its business in the enterprise space. As part of its growth strategy, Dell made six acquisitions for the year-to-date. Dell said that it "saw a tough macroeconomic and competitive environment." The view was similar to that of HP.
Dell revised its earnings forecast to $1.70 per share, below the $1.90 consensus.
Dell's weak results support a view that PC sales are worsening. Along with considering weak results from HP, IDC predicted PC shipments would rise 0.9% for the year. Still, notebook sales are expected to continue growing in the double digits. This would be good for Dell and HP, and especially Microsoft (MSFT), Intel (INTC), and AMD (AMD).
Markets sold off Intel shares last week, as shares dropped 5.39% in that period, while AMD shares dropped 3.9%. In July, when Intel reported earnings, the company revised its outlook for the year. The company expected revenue to increase just 3-5%, below its previous expectation of growth in the high single-digits. Intel's warning is consistent with the view that computer sales will remain under pressure.
Companies in transition tend to trade at larger discounts than its peers, because uncertainty in its future is elevated. HP shares are especially undervalued, reflecting an uncertain future with little expectation for growth.
Weak results from related companies in the sector, including Intel, Dell, and AMD, confirm that HP will be under substantial pressure for the rest of the year. Investors are clinging to one bright spot for the industry: the launch of Windows 8 on October 26, and the Windows Surface tablet. Investors should recognize that HP plans to focus on a Windows 8 tablet at the commercial level. Increasing sales in this space should help improve margins, as compared to the lower margin consumer space.
A re-design of HP's line-up concurrent with the Windows 8 will provide an unexpected boost for HP shareholders. Along with reducing operating costs, HP is set to be a more nimble company. Shareholders with the patience to ignore the short-term weaknesses will be rewarded in the long-run.