HP: Don't Fall For This Trap

Sep.14.12 | About: HP Inc. (HPQ)

Hewlett-Packard (NYSE:HPQ) announced it is cutting an additional 2,000 jobs, bringing the total job cuts to 29,000. These employees are expected to leave the company by fiscal year 2014. This is in line with the company's plan to save on operating costs. Since the surfacing of its current CEO Meg Whitman, it has resorted to reducing its workforce to improve its profitability. Following this announcement, the company will be laying off 8.3% of its total staff.

The company did not give specific reasons for the additional job cuts, but it seems obvious that the reason is to save on costs and increase its operating efficiency. The technology giant has experienced tough times with the advent of tablets and other mobile computing devices. According to market research firm NPD DisplaySearch, tablet sales growth is expected to surpass notebooks by 2016. It said that the mobile PC category will increase from 347 million units this year to more than 809 million mobile devices in 2017. The research firm believes that a big chunk of growth will be attributed to North America, Japan and Western Europe. There is a huge consumer preference for mobile computing devices such as tablets in mature markets.

At present, the silver lining is that the decline in PC units will not be as bad as expected. The launch of Microsoft's (NASDAQ:MSFT) Windows 8 and Intel's (NASDAQ:INTC) Ultrabook will limit the overall decline. Another research firm IDC said that the launch of Windows 8 in October will boost the sluggish US PC market. It sees an increase of PC market sales from flat growth to moderate growth of 5%. Despite the introduction of Windows 8, it reduced its global PC forecasts. For the next 3 years, IDC estimates that worldwide PC shipments will grow by 7.1% a year. This is lower than the previous forecasts of 8.4% a year. The downward revision of its forecasts is due to the tough macroeconomic conditions both in the US and the European region. It also believes that the Asia-Pacific market appears to have softened.

Also HP will continue to see more challenges ahead. Recently, Lexmark (NYSE:LXK) announced that it will exit from the printing business in an effort to restructure its own business. The announcement will also result in the elimination of 1,700 positions worldwide, which includes 1,100 manufacturing positions. While the closure of Lexmark seems positive for HP, this will not have significant impact in the long run. There is a secular change in the printing industry as consumers have also shifted to tablets and smartphones for their media consumption. This effectively reduces the need for consumers to print handouts.

Following Dell's Lead

For the last 10 years, Hewlett-Packard had average revenue growth of 10% a year. But the last few years have been lower. On a year-to-year basis, revenues have grown by 0.96%. This is lower than the 5-year average growth of 6.78%. I expect that this would be the same story for this year. In fact, Meg Whitman acknowledged that the PC units sold through the distribution channel have continued to soften.

Operating margins have somewhat painted a different picture. It improved from negative margins of 1.8% in 2002 to 7.6% in 2011. But, I note that the operating margins have declined recently. Operating margins were at 8.8% in 2008 and 7.6% in 2011. The steady margin is due to new businesses such as enterprises solutions, although these segments have lower contribution than the traditional business.

Meanwhile, Dell (NASDAQ:DELL) has lower revenue growth performance. It had an average revenue growth of 7.13% for the last 10 years. It has the same trend with Hewlett-Packard. For the last 5 years, revenue had an average growth of 1.57%. On a year-to-year basis, revenues have grown by 0.94%. I expect that Dell's PC sales will continue to weaken for this year. It recently reported that consumer revenues have dropped by 22% from a weak consumer environment and tough macroeconomic concerns.

There are two ways to boost profitability. The first strategy would be to acquire companies and increase its growth. But, this would be costly and would have a toll on the company's financial position. Given the current environment, there is a strong need for technology companies to have enough cushion against uncertainties. Another strategy is to cut down costs. This appears an easy option for a struggling company. It needs to constantly review its operating process to shed off unnecessary procedures. This entails closure of non-core business segments.

It seems that Hewlett-Packard is following Dell's lead. Dell has announced that it is preparing to cut its UK workforce, although it remained tight-lipped on the number of job cuts. It said that it needs to improve its operating efficiency to improve its overall profitability. As previously discussed, Dell has been struggling with its sales growth over the last few years.

Hewlett-Packard Valuations at Multi-Year Lows

At the current price, the stock is trading at 4.3 times 2013 earnings and 1.1 times book value. This is significantly lower than its 5-year average of 13.1 times and 2.4 times book value, respectively. It also carries a dividend yield of 2.8%. These valuations imply no growth for Hewlett-Packard for the coming years as investors are unwilling to pay a premium on the stock.

In contrast, Dell trades at 5.1 times earnings and 1.9 times book value. This is lower than its 5-year average of 13.2 times earnings and 5.1 times book value. The premium valuation over Hewlett-Packard is due to the market's view that Dell has a better plan to address the current environment. Recall Hewlett-Packard has several management changes over the past few years, suggesting a lack of company direction.

Other stocks like Intel and Microsoft have higher valuations. Intel is valued at 9.5 times earnings and 2.4 times book value. On the other hand, Microsoft is also valued at 9.3 times earnings and 3.9 times book value.

Hewlett-Packard has a long way to go. It is currently implementing various strategies to revitalize its profitability. Investors would like to see improvement on its restructuring plan, as well as its move to drive growth and improve its balance sheet. The additional job cuts only signals the company has yet to reach its bottom.

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.