Is This Earnings Rally Justified?

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

In my recent articles I have discussed the predicament of Hewlett Packard (NYSE: HPQ). The company has gone from being the biggest printer and PC manufacturer to one of the most disliked companies in the stock market. This ‘fall’ is due to a number of factors, but the rise of handheld devices is one of the primary reason behind the troubles of HP. The increased usage of smartphones and tablets has affected both the printing and PC industry. The recent PC figures by Gartner are not a good sign for the future of the PC industry, but there is hope that Ultrabooks can rescue the falling sales. If there is any possibility of this turnaround, Microsoft’s (NASDAQ: MSFT) Windows 8 will have to play a major role.

Earnings

HP reported its 1QFY13 results last week. The market was expecting HP to report an EPS of $0.71 on revenues of $27.8 billion. The company comprehensively beat estimates by reporting a non-GAAP EPS of $0.81 and revenues of $28.4 billion. The healthy growth resulted in stock appreciation of 6.4% in aftermarket trading. The stock has depreciated approximately 40% in the last year, and despite stellar earnings it will have to do a lot more to restore investor confidence. Positives from the quarterly report include the stabilizing revenues from printer, improved cash position and better than expected Enterprise performance, with the decline limited at 4% y/y.

Net income saw a decline of approx. 16% y/y to 1.23 billion from $1.47 billion. This decline was fueled by declining margins and declining sales in the PC and printer business. During the quarter there was a revenue decline across all segments, with only the networking segment showing a meager 4% growth. This decline was the steepest in the PC segment with 8% followed closely at 5% by the printing segment. The cost cutting plan at HP is finally taking shape with the company planning to lay off another 29,000 employees in the next two years. Almost 15,000 employees have already left the struggling giant, which has been one of the reasons behind improving margins.

The misguided acquisition has left question marks on the once formidable cash hoard of HP. The street has been worried about the company being able to finance its turnaround efforts. The current quarter sheds a hopeful light on the cash position with the company reporting FCF of $2.06 billion, or $1.05/share. According to the sell side, the cash situation benefited from better receivables and $127 million in sales of PP&E.

Competition

HP’s segments operate in mature markets so understandably the company operates in a tough competitive environment. While the enterprise segment is important to turnaround efforts for HP, the performance in the printing and PC segment will decide the future of the company. The PC segment is not only hotly competitive but is also undergoing a radical transformation to touch based systems. Microsoft has jump started this evolution with the introduction of its Windows 8 operating system. Manufacturers such as Dell (NASDAQ: DELL) and HP have already launched a number of hybrid tablets to tap the growing tablet market.

To make matter worse, Microsoft has also launched its own Surface RT and Surface Pro tablets. The company has seen a good response to RT but a mild one to the Pro. The software giant was forced to sell the hardware on higher price points to ensure its OEMs such as HP and DELL get a fair shot at selling their own products. Meanwhile, the situation is getting worse in the PC segment with Gartner reporting another decline in PC sales.

According to the research firm the PC sales have declined by 4.5% in the fourth quarter of 2012. HP has regained control of the market and has increased its market share to 16.2% as compared to 15.5% in the 4Q 2011. Dell has also suffered from the decline in PC industry with the company going private in an attempt to move away from the Wall Street spotlight. According to Gartner Dell’s share of the PC market reduced from 12.2% in 4Q 2011 to 10.2% in 4Q 2012.

Bottom Line

The earnings show that HP is headed in the right direction with cost cutting resulting in higher margins. The stabilization of the PC market share should also be good news for investors as the company drives a large part of its revenues form PC. The penetration of Microsoft’s Windows 8 into the highly competitive tablet market and the success of hybrid devices will determine the fate of the PC industry. I recommended that investors buy HP when it was trading in the range of $13-$14, but I believe the company will have to dish out more fundamental positives before it can push the $20 mark.


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