Hewlett-Packard: Looking Past the Recent Weakness

A couple of weeks ago, Hewlett-Packard released its third-quarter results that were not up to the mark. The company's revenue was down year-over-year, while its earnings also dropped. In fact, Hewlett-Packard's top line fell 8% from last year to $25.3 billion, while its net income dropped 13% from the year-ago quarter.

Looking past the weakness

However, the good thing was that Hewlett-Packard's earnings in the quarter exceeded the company's own outlook, and it expects earnings growth in the current quarter. Now, Hewlett-Packard reported a contraction in both its top and bottom lines primarily due to substantial restructuring charges borne by the company during the quarter.

But, in my opinion, things should improve going forward as HP has a well diversified business in terms of both operational segments and geography.

Looking ahead, since HP is focused on expanding its operations across the globe while diversifying its product and services portfolio, it should be able to increasingly attract both home users and enterprise customers.

The headwinds

The decline in the company's top line growth in the past year can be attributed mainly to sharp currency headwinds that it has faced as a result of a continuously changing global economic environment. However, HP's revenue growth in constant currency terms has remained steady, which indicates that if we exclude the effects of currency translations, the company's performance would have been better.

Additionally, HP's top line growth will pick up pace in the long run due to its well-diversified operations spread across the globe, and through strategic introductions of products and services from time to time. This will play a key role in helping HP to improve its cash flow performance going forward, which has suffered as a result of weak revenue growth.

However, the good thing is that despite weak top and bottom line growth, HP has remained a shareholder-friendly company that's returning cash to shareholders. For instance, HP returned $670 million to its stockholders through dividends and stock repurchases during the third quarter. Now, this might look like a positive at first, but returning cash to shareholders at a time when the business is not doing well is taking a toll on HP's cash flow performance.

Due to a drop in its free cash flow and operating cash flow, HP might be forced to slow down its research and development activities in order to cut costs and sustain the buyback and dividend program.

Mixed sentiments

Given HP's weak financial performance, it isn't surprising to see that there are mixed views among analysts about the stock. For instance, the consensus estimate among 32 analysts that evaluate Hewlett-Packard indicates that the company will outperform the market. Surprisingly, this estimate has been maintained since the analysts upgraded their view in February last year. The earlier consensus estimate had suggested investors to hold their position in the company. But for most of 2015, HP shares have declined, which defeats the positive investment view on the stock.

On the other hand, Moody's Investors Service recently downgraded the senior unsecured rating of Hewlett-Packard to Baa2 from Baa1, and reiterated the Prime-2 short term rating. The action was primarily driven by the estimated spin-off the enterprise business and the company's market position in personal computers and printing. However, there are growth hurdles in both segments that are expected to weigh on its financial performance.

An impressive valuation

Despite headwinds, HP's valuation is quite attractive. The company carries a trailing earnings multiple of 11.5, while its forward P/E multiple stands at 7.55. This clearly indicates that analysts expect HP's earnings to grow in the next one year.

However, given the challenges that the company is facing, I think it will be wise for investors to wait and watch how HP performs in the coming few quarters before taking a call on the company.

Published on Sep 4, 2015
By Harsh Singh Chauhan

Copyrighted 2020. Content published with author's permission.

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