HP: Buy, Sell, or Hold?

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

IBM (NYSE: IBM), Microsoft (NASDAQ: MSFT), Oracle (NYSE: ORCL), and Cisco are giants in the tech sector, delivering a full range of hardware, software, and services to run the biggest corporate computing operations in the world. But what about Hewlett-Packard (NYSE: HPQ), another tech titan? Unfortunately, if the company is not missing out on a move to mobile devices, it is making investors unhappy with its less than stellar returns. The latest news is that it UBS has lowered its price target to $12.75 from $14 for HP.

I see Hewlett-Packard facing even greater challenges in the future. I believe its stock is slightly overvalued at its current price of around $14 per share, and that it could decrease if it does not overcome the challenges it faces. Hewlett-Packard has been trying to disentangle itself from its deteriorating net income, disappointing return on equity, poor profit margins, weak operating cash flow, and generally high debt management risk.

Hewlett-Packard may face further challenges for several reasons. First, it is experiencing sales declines in all its core business units except software, which saw revenues rise 18%, albeit not organically - its $10 billion deal for Autonomy, completed last October, contributed to it. Second, Hewlett-Packard has little or no continuity. The company has had 7 CEOs since 1999, compared to Oracle, where Larry Ellison has been at the helm as long as Oracle has been. Third, R&D spending in recent years fell to commodity hardware levels at about 3% of revenue. Finally, Hewlett-Packard never seems like it has a long- term plan. It began as a maker of instruments for scientists and engineers and has lost its way.

Hewlett-Packard reported third quarter results recently that showed net revenue of $29.7 billion, down 5% from the same period last year, and down 2% when adjusted for the effect of the currency. AAP loss per share was $4.49, down from earnings per share (EPS) of $0.93 in the prior year period. Non-GAAP diluted EPS was $1.00, down 9% year over year. The figures showed that the company suffered its biggest ever quarterly loss in its history.

The gross profit margin of Hewlett-Packard is currently lower than desirable, coming in at 26.30%. Its debt-to-equity ratio of 0.94 is low, but it is high when compared to the industry average. Unfortunately, its net profit margin of -29.90 is not good enough when compared to the industry average. Net operating cash flow has greatly decreased when compared to its ROE from the same quarter one year prior.

Lenovo Group reported second quarter profit of 13%, expanding market share to overtake Hewlett-Packard in personal computer shipments. To ensure Hewlett-Packard can't catch up, it is making full use of the PC division of IBM it bought in 2005. It also wants to extend its dominance to smartphones, and the unit making mobile devices almost tripled sales through the first six months of the year.

IBM, another of Hewlett Packard's rivals, also has challenges, but it is reorganizing. It has continued to invest in research and development, spending as much as 6% of revenue on it every year. It is cooking up 5-year plans that work, restructuring its portfolio to catch secular trends and keep Hewlett Packard at bay.

Oracle is betting on integrated hardware and software systems. Its plan is simple: when it comes to database, take the latest technology and absorb it. Hewlett Packard, its rival, is unable to compete with juggernauts that launch plans, stick to them, and know what they are about.

It is difficult for Hewlett-Packard to have continuity when the company creates plans based on what the CEO knows best. The company went down the hardware road when Mark Hurd was around, acquiring 3Com, 3Par, Palm, and others. It went down the software road when Leo Apotheker was CEO, and $10 billion went into purchasing Autonomy. Meg Whitman, in her debut, spoke about better execution, harnessing a talented workforce, hitting metrics, strategy, and innovation.

Hewlett-Packard recently strengthened its mission-critical converged infrastructure portfolio with innovative and enhanced HP integrated system to triple performance, boost resilience, and deliver investment protection for critical workloads deployed into the next decade. The solution offers scalability, continuous availability, efficiency needed by clients to achieve their mission-critical business goals and improve productivity. "It demonstrates HP's continued commitment to transform the server landscape with innovations to the integrity portfolio," said Ric Lewis, Hewlett-Packard's vice president and interim general manager.

In addition to this, Hewlett-Packard is said to be in talks with Google about incorporating Google's Android operating system into a slate or tablet style computer later in the year. It is still unclear what impact this will have on Hewlett-Packard's relationship with Microsoft.

Hewlett-Packard may be in the early stages of a multi-year turnaround and making some progress despite the headwinds, but its initiatives need to be seen as promising. Hewlett-Packard can best be compared to Dell (NASDAQ: DELL), Accenture, and IBM, big hardware companies that missed out on the mobile curve.

Hewlett Packard's price-to-earnings ratio is 0.22, competitive when compared to 1.79 for Accenture, 0.26 for Dell, 2.06 for IBM, and 2.11 for industry average. But its gross margin is 0.23, less than the 0.32 for Accenture, 0.26 for IBM, and 0.44 for the industry average. Its earning per share is not good enough at -2.81, compared to 3.84 for Accenture, 1.68 for Dell, and 13.91 for IBM.

Furthermore, Hewlett-Packard's revenue is falling quarter to quarter. Hewlett Packard should be well positioned to offer a range of products and services for sustained growth, but it hasn't been able to accomplish this. I recommend that shareholders hold onto this stock on the strength of its continued dividend payments, but I will not advise investors to buy it.

StockCroc1 has no positions in the stocks mentioned above. The Motley Fool owns shares of International Business Machines, Microsoft, and Oracle. Motley Fool newsletter services recommend Dell, International Business Machines, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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