Don't pin hopes on HP
By MATHEW INGRAM
Globe and Mail Update
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Hewlett-Packard (hpq-n)
After several days of weakness in the tech sector, investors were looking for a little sunshine, and so on Wednesday they latched onto strong results from Hewlett-Packard. The computer and printer maker reported a healthy profit and better-than-expected sales for its latest quarter, and that helped boost the stock by more than 7.5 per cent at one point. HP's bullish forecast for the year also helped push the Nasdaq composite higher by almost 2 per cent. But were the company's results really worth getting all that worked up about? Not really — at least, not if you look below the surface.
HP reported that it made a profit of $884-million (U.S.) or 29 cents a share, up 34 per cent from the $659-million or 22 cents a share it made in the same period last year. After excluding a one-time charge of $70-million — for a legal settlement with the government of Canada — the company made 34 cents a share, which was the consensus target from analysts surveyed by Thomson First Call. HP's revenue climbed by almost 12 per cent to $20-billion from $18-billion a year ago, beating analysts' estimates of $19.3-billion in sales.
It's worth noting, however, that much of HP's revenue boost — as with its international competitor, IBM — came from the fluctuation in the value of the U.S. dollar relative to other global currencies. Without the positive effect this provided, HP's sales for the quarter would only have risen by about 4 per cent, which isn't quite as exciting.
Still, it all sounds pretty great, doesn't it? Sales up 12 per cent, profit up 34 per cent. No wonder the market reacted so favourably. And yet, there are a number of question marks about HP that become obvious when you look under the hood — many of them the same ones that have hovered over the company since it acquired Compaq Computer in 2002 for $20-billion. How can it compete in the ongoing war of attrition with market leader Dell in the PC business? How can it grow its services unit and compete with IBM? And lastly, how does it deal with the fact that the first two factors leave it dependent on its legacy printer business — which Dell is also encroaching on?
The numbers tell the story: HP's personal computer business had an operating profit of $45-million on sales of $6-billion, a return of less than 1 per cent. In fact, the company's finance arm had a profit almost as large on less than one-tenth the revenue. HP's software and services unit did better, with an operating profit of $400-million on sales of $7.7-billion, but that's still a return of just 5 per cent. And that's operating profit - before expenses. As usual, the big mover for HP was its printing unit, which made an operating profit of almost $1-billion on sales of $6.1-billion, for a return of 15 per cent.
While the company stressed the fact that operating profit rose for all three divisions, those are still some pretty anemic numbers for PCs and services. Analysts also noted that the company said its gross profit margins dropped in the quarter, to 25.2 per cent, as a result of what HP said were industry pressures on server prices, storage equipment and printing supplies. The latter isn't an encouraging sign for a division that makes up such a large proportion of HP's annual profit. In the PC business, HP also lost market share to Dell in every category.
Several brokerages kept their "buy" ratings and CIBC World Markets upgraded HP, but others weren't quite as gushing. Bear Stearns said the quarter was better than expected in some areas, but it maintained its "peer perform" rating because of the lower gross margins and other competitive issues, and said that its "long-term strategic concerns remain." Needham & Co. also kept its "hold" rating, saying the quarter was reasonably good but that HP was still relying on its traditional strength in printing for too much of its profit. That unit made up more than 70 per cent of the company's operating income, Needham pointed out, while the PC and services units — which make up 50 per cent of HP's overall revenue — contributed just 8 per cent.
Needham said that the "anemic performance" of the company's personal and enterprise system groups "continues to call into question HP's merger with Compaq two years ago." And while the company's printing division has yet to show much effect from Dell's entrance into the market, Needham said this is likely to change, since Dell has said that the market is a strategic priority. Dell is likely to become increasingly aggressive, the firm said, and this could impact both HP's printer revenue growth and margins. This is a key reason for its hold rating, Needham said, and the other is that "HP has yet to come remotely close to producing value-creating returns on its personal and enterprise systems businesses."
The bottom line is that HP still hasn't shown much consistent benefit from the Compaq merger, nor has it shown that it can make much money on its PC or services units. That leaves printing, a market where Citigroup says HP suffers from a "persistent cost disadvantage versus Dell" because of Dell's direct model. In all, not a great recipe for optimism. |
