Computer and hardware maker Hewlett Packard (HPQ) painted a gloomy outlook for its 2013 fiscal year at its analyst day. According to CEO Meg Whitman, the 2013 fiscal year will be a transition year, as the company looks toward reinventing itself and becoming a leaner, more effective company. Though the transition isn't expected to be completed until the end of fiscal year 2014, 2013 will take the brunt of the pain. Still, Hewlett Packard is ridiculously cheap. Check out our valuation analysis here. But that doesn't mean it can't get a lot cheaper, and that's why combining both value and momentum analysis is key to generating outsize returns (discover why here). It prevents valuentum-style investors from entering into massive value traps.
Net of restructuring costs, fiscal year 2013 earnings look to be $3.40-$3.60 per share-meaningfully lower than the consensus estimate of $4.18 per share. Further, essentially every division within the company looks like it will be quite weak. HP Enterprise Services expects revenue to fall 11%-13%, with operating margins of 0%-3%. While several competitors have focused on building stockpiles of cash with high-margin services businesses, HP hasn't had a favorable sales mix, leading to several low margin businesses with disappointing returns on invested capital. Long-term, the company expects the segment to grow 3%-5% annually, with 7%-9% operating margins, as it migrates 80% of its services revenue to data center contracts (with the other 20% coming from cloud-related business). We think this is a rather ambitious plan, especially considering the fierce competition in data center-one of the few growth drivers remaining for big tech.
The HP Printing and Personal Services segment looks like it may even be in worse shape. The fall of the PC is well-documented, but slightly exaggerated, in our view. However, we do strongly believe that Apple (AAPL) is the only personal computer maker selling a differentiated product that consumers want, in our view. For most consumers not purchasing a Mac, they are pleased as long as the computer runs Windows (MSFT) on an Intel (INTC) chip. Whether a computer is an HP, Dell (DELL), or Gateway is secondary now that products have become so commoditized. HP also wants to re-enter mobile computing, but we're not sure it will be able to compete with the likes of Apple or Amazon (AMZN). Still, the firm has a strong printing business, which should continue to throw off a good amount of cash, though it, too, is in a secular decline. The company will focus on eliminating unnecessary products to streamline production to aid profits in this segment.
The Enterprise Group's future looks brighter, as the company has been able to gain share in the enterprise server and data storage businesses. The firm will continue to provide customers with integrated software offerings. However, the enterprise market is one of the last growth engines remaining for big tech, so competition from IBM (IBM), Accenture (ACN), Oracle (ORCL), and Salesforce.com (CRM) will remain fierce. We think HP will have to acquire young software firms at lofty multiples to "keep up with the Joneses."
Ultimately, we aren't very excited about the near-term picture at HP. Though cash flow remains fairly robust, it will be sensitive to both secular declines and macroeconomic headwinds. Turnarounds are notoriously underestimated in both difficulty and duration, so it's possible HP's stock languishes until 2016 or 2017, in our view. If it does work, shareholders could be able to reap massive rewards. Still, after considering the risk and opportunity cost of such an investment, we're not ready to dive in head-first. Therefore, we aren't interested in adding the tech giant to the market-beating portfolio of our Best Ideas Newsletter at this time.
Additional disclosure: Some of the firms mentioned in this article are included in our actively-managed portfolios.