Global computing giant Hewlett-Packard (click ticker for report: ) reported weak quarterly results Wednesday afternoon and issued an equally bleak outlook. Revenue tumbled 5% year-over-year to $29.7 billion for the firm’s third quarter, which was about $400 million worse than consensus expectations. Earnings per share, adjusted for $10.8 billion of charges, mostly related to a write-down of Electronic Data Systems, were a few cents better than consensus expectations, though they did fall 9% from a year ago. Looking ahead, the company’s full-year earnings guidance came in slightly below the Street’s expectation of $4.07 per share, in the range of $4.04-$4.07 per share, though we think CEO Meg Whitman may be setting low hurdles to exceed earnings.
HP’s poor quarter echoes the results we saw from Dell (click ticker for report: ) earlier this week. Industry-wide PC sales continue to slump, and HP’s revenue in its personal systems group fell 10% year-over-year to $8.6 billion (on a similar drop in aggregate unit demand). The segment’s 4.7% operating margin is certainly nothing to write home about, but it is much stronger than the 0.5% operating margin Dell posted in its consumer segment earlier this week.
However, Whitman admitted that “channel inventories were high,” or that the firm is stuffing the retail channel with product. Weak results from computing come as no surprise given the anticipation of Microsoft’s Windows 8 (click ticker for report: ). However, we think consumers are gravitating towards the best value PCs if they aren’t purchasing Mac computers (click ticker for report: ), so both HP and Dell could face pressure from low-end competitors going forward. Such a trend is a mixed bag for Intel (click ticker for report: ), though the firm will benefit from supplying Mac computers that continue to take market share. However, low-end PC makers like Lenovo could choose to use cheaper Intel chips like i3 and i5 processors, which would hurt Intel’s profitability.
Traditionally, the firm’s Imaging and Printing Group has been a strong performer, but revenue fell 3% year-over-year to $6 billion. Undoubtedly, the demand for paper is in long-term decline. However, we expect there will be some natural minimum threshold and perhaps HP could be one of just a few players remaining in this market. Of course, enterprise shifts towards tablets—read iPads—could really crush this business, especially if adoption accelerates. Whitman conceded the consumer market to Apple, but we also think it will be very difficult to compete with the world’s largest company in the enterprise space.
The firm’s Services segment also struggled, with revenue slipping 3% year-over-year to $8.7 billion. Management remarked on the conference call that some of the decline can be attributed to a decline in IT outsourcing, which fell 6% year-over-year, as the company eliminated contracts that didn’t boast ample profitability. Whitman specifically addressed the company’s need to discontinue EDS’ low-margin services business. We’ll keep a watchful eye on this segment, which we suspect will house many of the firm’s announced 10,000 – 15,000 job cuts in its Enterprise Services segment.
Not surprisingly, HP wants to focus on growing revenues in the highly profitable software segment, which accounted for less than $1 billion of revenue during the third quarter, though it did grow 18% year-over-year. We’ve seen IBM (click ticker for report: ) successfully make the transition from hardware to enterprise software, but the space is highly competitive between major players like Oracle (click ticker for report: ), Accenture (click ticker for report: ) and SAP (click ticker for repot: ).
Though HP is certainly in the midst of a turnaround, the company continues to generate a significant amount of cash flow. In its reported third quarter, the firm generated $2.8 billion in operating cash flow and $2.1 billion in free cash flow (which the firm is using to pay down debt). As long as HP continues to generate plenty of cash, the balance sheet will improve and the firm will have no problem surviving.
We think shares are incredibly cheap right now, trading at less than 5 times 2012 earnings and at a tremendous discount to our fair value estimate range (based on our DCF process). Though we think the company has better prospects than Dell at the moment, we aren’t rushing to establish a position in HP, which scores just a 6 on our Valuentum Buying Index (our stock-selection methodology). We may become more interested in a position for the portfolio of our Best Ideas Newsletter if the firm’s technicals improve or if the stock becomes too cheap to ignore (it’s not there yet).