Does HP Have a Silver Lining?

Lior is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Some analysts think Hewlett-Packard (NYSE: HPQ) isn’t going anywhere. After all, the company’s revenues declined in 2012 by nearly 5.4% compared to 2011. Moreover, the industries the company operates in including personal computers and printers are stagnating and are likely to limit the possible growth of its revenues in the near future. So where does it leave Hewlett-Packard? Is HP’s situation so dire?  

“Limitless paper in a paperless world”

I remember this slogan that was first articulated in NBC's hit TV show "The Office." The decline in the paper industry as presents in the TV show isn't limited to paper and should also be attributed to related products such as printer and fax machines. Hewlett-Packard, among the leading manufactures of printers, operates in this stagnating industry. For example, in 2011 the number of printers sold grew by 0.7% compared to 2010. Despite this modest growth, it didn't go to HP's sales. According to IDC, printers' shipments of HP fell by nearly 0.7% in 2011, while other companies' printers' shipments of Canon, Samsung and Brother rose during the year. 

In HP's recent quarterly report, net revenues from printers and related products declined by 6.5%. But this wasn't the only segment that contracted in the recent quarter.

Personal computers sales fell during fiscal year of 2012 by nearly 10% compared to the 2011. The change in individual preference from using personal computers to using tablets and Smart-phones means the personal computers' industry is contracting. 

Other segments' net revenues from services and "Enterprise Servers, Storage and Networking" also declined during the year by 2.2% and 7.1%, respectively.   

The only major business segment that expanded in the recent quarter was software segment: the revenues from this segment grew by nearly 20.6%. Alas, this segment represents only 3.4% of the total net revenues of the company.  So is the company's situation so dire?

Even though the company did show a loss of nearly $11 billion, most of this loss is due to accounting changes in goodwill and intangible assets of nearly $18 billion. After controlling for this provision, HP's loss becomes a profit. But this profit was still 34% lower than the profit recorded in 2011; the adjusted profitability fell from 8.3% in the fiscal year of 2011 to 5.8% in 2012.  

So the company’s was still profitable in 2012 even though its profitability declined compared to the previous year.

But one of the main reasons many investors consider to invest in such a highly volatile company is its potential growth. This is the main problem the company is facing. The potential growth of the company in its business segments of printers and personal computers is less likely as these industries are contracting. This means, HP will need to reach new markets. The company’s decision to enter the tablet and Smart-phones industry might eventually turn to be a good bet. But the burden of proof lies on the company’s management. Entering these industries is hard for an already highly competitive market.  

The company is putting a lot of effort in reinvesting itself: the company’s R&D budget rose by 4.5% in 2012 and represents nearly 2.8% of its net revenues. In comparison, a giant like Apple (NASDAQ: AAPL) allocated only 2.2% of its revenues to its R&D in 2012 (for 52 weeks until September 2012). In 2011, the company's R&D was also only 2.2% of its total revenues. Nonetheless, Apple’s R&D expenses grew by nearly 39.2% in 2012 compared to 2011. But since Apple's revenues grew by nearly 45%, such a rise in its Research and Development provision is less impressive.     

So the growth isn’t likely to come easy; how is the company’s cash flow?    

Cash Flow and Financial Risk

Despite HP's loss, the company still has cash on hand with nearly $11.3 billion. During the 2012 fiscal year, the company's net cash from operating activity was nearly 10.5 billion and the free cash flow (cash flow from operating and investing activities) reached nearly $7 billion. This gave the company the opportunity to repay nearly $2 billion of its debt and buyback almost $900 million of its stocks. The company was also capable to pay nearly $1 billion of its dividend with its free cash flow.

This is one of the silver linings of HP: it has the cash to stay afloat even if its operations will continue to slowly decline.  

Dividend Yield and Payment

I think the main reason people may consider HP as an investment is not only its relatively low financial risk but also its relatively high dividend yield for the industry. As of recent quarter, HP paid a quarterly dividend of $0.13, which is nearly a 3.09% annual dividend yield. In comparison, Xerox (NYSE: XRX) is offering a dividend of 4 cents per share, which reflects a yearly yield of 2.19%; Dell (NASDAQ: DELL) is paying a $0.08 dividend, which comes to a 2.44% annual yield. But for Xerox and Dell the risk attributed to the dividend payment is higher than that of HP: the free cash flow of these companies (calculated by the sum of operating activities and investing activities cash flow) is negative or nearly zero: in the first nine months of 2012 the free cash flow of Xerox reached $206 million, which is barely enough to cover the company's $195 million dividend payment. For Dell the free cash flow was nearly ($1,707) million, which means the company isn't able to cover its $139 million dividend payment from its operating activities. As stated above the free cash flow of HP was more than enough to cover the company's dividend payment of nearly $1,015 million.    

Bottom Line

HP is still a leading company in the printers and faxes industry and still has enough cash to make its dividend payments and stay afloat. So its financial situation isn’t dire as many might think. Nonetheless, the industries the company operates in are contracting. So this company isn't growing and unless it will reinvest itself, HP will continue to slowly dwindle in coming months and the demand for its stock will mostly likely follow.  

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Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.

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