Put This Dog Out of its Misery
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I know that everyone wants to root for the underdog, but in this case putting the dog out of its misery might be what's needed. Hewlett-Packard (NYSE: HPQ) seems to be stuck in a long slow decline, and in the company's most recent earnings report the only positive I could find was the dividend is well covered. I've heard the argument that investors should hold the shares with their 3.1% yield to give this company a chance to turn around. However, if I'm going to hold a stock with a 3% yield, there are many other options that don't require belief in what is seemingly a dying company.
Hewlett-Packard only has one problem, but it's killing the company. The company is the largest seller of PCs and no one seems to make money in this industry. The company's reported results show revenue down 5% and non-GAAP earnings per share down 9%. While each of the company's divisions showed some weakness, there are a couple things the company can do if it's serious about changing its fortunes. Let's take a look at each of the divisions to see just how bad things have gotten.
Personal Systems is the Problem:
The company's Personal Systems Group is the major problem with Hewlett-Packard. In this division, revenue was down 10% and essentially every underlying business was weak. Commercial revenue decreased 9%, consumer revenue decreased 12%, and sales of both desktop and notebook units were down as well. Unfortunately for Hewlett-Packard, this trend is not company specific. In the PC industry, the company competes against players such as Dell Inc. (NASDAQ: DELL), which has been struggling in its own PC division. In the most recent quarter, Dell reported revenues in their PC sales down 22%. In fact, this leads me to the first thing that Hewlett-Packard could do to become more relevant, and that is to spinoff or sell their Personal Systems Group. Without personal systems, revenue would have been down 2.54% instead of 5% as reported. In addition, earnings before taxes would have actually increased 2.87% instead of being down as well. While many people including myself have had good experiences with HP products, the PC business is simply not profitable and needs to go away.
Printing Sales Driven by Commercial Customers:
For most people, Hewlett-Packard equals printers. With revenue down 3%, but commercial revenue and units up 4%, we can clearly see where the problem lies and that is again with personal printer sales. While some of this challenge is a change in behavior as people are using less paper and more electronic communications, some of the challenge is simply Hewlett-Packard. The company produces a long list of printers for consumers to choose from, when in reality the product lineup could probably be simplified. A search on Amazon.com for “HP printer” under all-in-one printers, turns up over 400 results. For a consumer shopping for a printer, this is just far too many choices. A smaller lineup with less choices, and less price points, just makes more sense. However, this is a division that the company will simply have to accept that consumers are not going to use paper and ink at the rate that they used to.
Even Dell is Doing Networking & Servers Better:
It seems like every time a technology company that sells hardware runs into trouble, the first thing you hear from analysts is the company will reinvent itself into a services company like IBM (NYSE: IBM). This is the theory behind the hoped-for turnaround at both Hewlett-Packard and Dell. The problem is, both of these companies still produce PCs. If either of these laggards hopes to really turn their business around, getting out of the PC business is the first step. The second step, is Hewlett-Packard must use this increased focus to improve results in their services and enterprise businesses. One big difference between Hewlett-Packard and Dell is, the fact that Hewlett-Packard saw weakness pretty much across the board in services and enterprise sales. You can really see the split between HP and Dell when you realize that Dell's server and networking business showed a 14% increase in their most recent quarter, compared to a 6% increase in networking at HP. The bad news for HP investors is, all other line items decreased. It seems that Dell and other companies are stealing business away from Hewlett-Packard.
Software is a Bright Spot, or is It?
The lone bright spot in Hewlett-Packard's report was their software division which showed revenue growth of 18% including the results of Autonomy. In fact, all sub divisions in software showed strength. The company's licensing revenue increased 2%, support revenue was 16%, and services increased 65%. While on the surface this looks like a big positive for the company, investors will have to wait for more comparable results once Autonomy has been part of the company for more than a year.
The Worst Numbers of All:
For anyone who believes in the turnaround in Hewlett-Packard, all I can say is watch the company's financials carefully. While the company's balance sheet essentially stayed the same, the company's cash flow dropped tremendously. In fact, operating cash flow dropped over 55%, and free cash flow was down better than 45%. The only positive was this cash flow created just a 13% payout ratio. Even with this low ratio, investors can't be too reassured by a better than 45% decrease in cash flow to run the business.
Conclusion:
The bottom line for Hewlett-Packard investors is they probably need to look elsewhere. Given the choice between owning HP with about a 3% dividend and 2.9% growth, or owning IBM with a roughly 2% dividend growing at over 10%, this is a no-brainer. I could even make the argument that Dell investors appear to be better off than Hewlett-Packard. Both companies pay a yield of about 3%, and both sell for low single-digit P/E ratios. However, Dell at least shows some strong results in servers and networking. In my eyes the old saying that Peter Lynch once used applies. He said, in some cases it's always darkest before the dawn, but sometimes it's always darkest before pitch black. Hewlett-Packard investors appear to be staring at a black hole for the next few years. Unless HP makes a decision to drop its Personal Systems business, I would choose just about any other tech company to invest in.
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