Hewlett Packard: 75% Profit Likely By Mid 2014

| About: HP Inc. (HPQ)

Hewlett-Packard (NYSE:HPQ) has not had a good going of late. Its stock is down over 14% in 2012 and most analysts are lukewarm to its prospects. When HP reports its first quarter earnings next week, it's expected to report earnings of 91 cents per share -- down around 27% from a year earlier.

The Personal Computer maker is clearly not a stock market darling. HP's Price-Earnings (P/E) ratio is just below 8, which is below that of the S&P500 (21) and the PC Sector (14). Like its chief competitors, Dell (NASDAQ:DELL), Lenovo (OTCPK:LNVGY) and Acer, HP has plugged away in an industry stuck in a vicious cycle of product commodification, tight margins and poor business prospects.

The silver lining for HP is that it regained the top spot in the PC market in the first quarter. Moreover, PC shipments actually increased by 21% -- and shipments of Desktop and Notebook PCs, which represent HP's staple, actually exhibited growth of 8% and 11%, respectively.

Unfortunately for HP, it missed out on the best-performing portion of the PC industry-- Tablets, which grew by 200% during the same period. That represents a missed opportunity and is partially a self-inflicted wound as HP cancelled its WebOS-based HP Touchpad and shuttered its WebOS division less than two years after acquiring Palm for $1.2B.

To make matters worse, with the ascendancy of smartphones and the advent of high-speed mobile Internet, consumer preferences have shifted. Notwithstanding the fillip in the first quarter, the PC industry is expected to remain in the doldrums this year, rising by only 4.4%, while shipments of Tablets are expected to rise by 90% in 2012 before eclipsing shipments of traditional PCs by 2013.

All that said, it's not all doom and gloom for HP. To begin with, 2012 is when Microsoft (NASDAQ:MSFT) is expected to begin shipping Windows 8. This will no doubt inject life into HP's profits as consumers and businesses upgrade their Desktops, Notebooks and Servers to coincide with the newest edition of Windows. Indeed, the 4.4% growth forecast for PCs only measures the first round of the upgrade cycle; Windows 8 should drive strong sales of PCs in 2013 as well.

More than this, however, Windows 8 represents Microsoft's first truly cross-platform version of Windows -- an operating system that will run seamlessly across both traditional devices like desktop PCs and mobile devices such as smartphones and tablets.

What this means is that, with Windows 8 running on HP hardware, HP can still gain a foothold into the fast-growing Tablet market. Indeed, HP has already indicated that it will be developing Tablets running Windows 8 for the under-served Enterprise market to coincide with the latter's release. HP intends to build consumer tablets as well, but building business tablets should give it an edge over Apple (NASDAQ:AAPL), whose iPad is largely targeted towards the consumer market.

Meanwhile, HP and its Windows PC cohorts have begun taking aim at Apple's traditional niche in the notebook market with the release of their own line of premium thin-and-light notebooks called "Ultrabooks" that run on Intel's (NASDAQ:INTC) low-power, high-performance processors.

This makes sense: when traditional (i.e. Desktop and Notebook) PC shipments fell by 5% in the 4th Quarter to 2011, Apple actually saw its own shipments increase by 21%. This suggests that consumers are willing to pay premium prices for well-designed and well-built "traditional" PCs.

One might argue that the PC industry has tried to copy Apple in the past -- and failed -- but Apple is taking this challenge seriously; it is upping the ante in the notebook sphere by leveraging its design aesthetic and is slated to announce an upgraded line of MacBooks bearing high-resolution "retina" displays.

Getting into the premium Notebook market will definitely help bring HP's average margins up. HP's average income per-PC is between $30 to $73 depending on the model. Premium PCs such as HP's Envy line typically cost 30 to 40% more, implying a per-PC profit of $101.

One might think that a PC-maker like HP would simply be intent to follow others' lead in areas such as Cloud Computing, but HP has actually bucked the trend and added its own flavor to the web services game by implementing its Cloud Printing service natively across newer models of its ubiquitous line of printers.

What's more, HP has introduced client-side software for both iOS and Android to provide printing-on-the-go services. iOS and Android users can print documents they receive while on the road by using HP's app to locate HP-powered "printing kiosks" and, once there, use HP's Cloud Print service to print their documents for a fee.

This is just the tip of the iceberg: HP is apparently planning to launch its own version of Amazon's (NASDAQ:AMZN) Amazon Web Services. This is significant as Amazon already has revenue run-rate of $2 billion from its Web Services division. Were HP to package this service with its ubiquitous Thin Client PCs to scale-up to AWS's size, it could, over time generate revenues equivalent to 11% of what it earns from its PC line. Moreover, because HP builds its own servers, it has a cost advantage over Amazon, implying that the cost of 1MB of data traffic would be as much as 20% cheaper for HP.


I believe that the market is unfairly valuing and overlooking HP on the basis of negative media perception of the PC business and the popularity of tablets and smartphones. For one thing, as I have already noted, HP is cheap on a comparison basis. At the same time, it provides investors with a 2.1% dividend yield, which is comparable or superior to the dividends of more celebrated stocks like Apple and Microsoft.

Indeed, some fund managers have already taken positions in HP as a value play. I'd do the same thing and expect HP investors to be rewarded with 75% profit on HP shares in the next 18 months.

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

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