WILL THE STREET SHOW LOVE TO HP ?
WILL THE STREET SHOW LOVE TO HP ?
2006-02-15 at 10:19:00 am #14271
Will the Street show love to HP?
HP has enjoyed rising earnings and better margins with its new CEO, but some say it’s got a long way to go.
February 2006: NEW YORK – Wall Street analysts and investors have showered Hewlett-Packard with affection since Mark Hurd took over as CEO last year. Will the love affair continue?
At least for now, the answer is likely yes. As with the last several quarters, analysts and investors expect the company to meet revenue expectations but deliver an upside surprise when it reports its fiscal first-quarter earnings after the closing bell Wednesday. Wall Street analysts expectHP (up $0.75 to $32.49, Research) to report sales of $22.5 billion and earnings per share of 44 cents a share, according to a Thomson/FirstCall survey.
HP’s earnings surprises have pleased the company’s followers, who are clearly happy with Hurd’s moves to cut costs and restructure the company, including announced plans to lay off some 15,000 workers. The company’s stock rose 38 percent last year.
But for some analysts, the honeymoon is over. While margins have improved and earnings have grown under Hurd, these analysts say he’s got some problems to address.
For one, profit margins in HP’s printer business, the crown jewel of HP’s businesses, are falling. HP’s printing business comprises between 50 percent and 60 percent of the company’s bottom-line earnings, depending on the quarter, according to Shaw Wu, an analyst with American Technology Research.
That number is down from when Carly Fiorina was CEO and margins were in the 70s, he said. The drop is in part because margins in other divisions have risen, but it’s also because profitability has declined in the printing business, Wu said. Neither he nor his firm own shares of HP.
Wu is concerned that the industry is shifting toward laser printers and away from inkjets. HP makes more money on inkjet printers than laser printers because it holds more patents related to inkjet printers, and also because consumers have to replace inkjet cartridges more often, he said.
Wu estimates that 70 percent of the printer division’s sales come from selling things like toner and ink cartridges. As Wu points out, that’s huge.
“Potentially 35 percent, 40 percent of the company is selling cartridges,” he said.
Momin Khan, an analyst with research firm Technology Business Research, said HP is losing market share in the printer market to Dell (up $0.43 to $32.00, Research), particularly with its inkjet and “all-in-one” printers. Khan said that HP will need to increase efficiencies to compete with Dell in this area. (Neither Khan nor his firm own shares of HP or Dell.)
But he added that both face a major new threat in the form of “ink refillers” that refill ink and toner cartridges for roughly 40 percent less than the cost of a new Dell or HP cartridge. Walgreens, the drugstore chain that currently boasts 5,000 retail outlets in the U.S. and Puerto Rico, is offering ink refiller stations in some of its retail stores.
Margins down for printers, but up elsewhere
While it faces challenges in its biggest division, HP is starting to realize some competitive advantages over rivals in other areas, however.
For one, unlike Dell, the company is not tied to using chips from Intel. According to Romeo Dator, co-manager of the All-American Equity Fund from U.S. Global Investors, HP is benefiting from the fact that it uses AMD (up $1.26 to $40.22, Research) chips in some of its laptop computers and servers, and AMD has gained market share from Intel (up $0.24 to $21.37, Research) in these areas. Dator’s fund owns a small position in HP.
“We have heard stories where salespeople from Dell have said, ‘We can’t compete (on) selling servers; the customer wants AMD’,” said Dator, who thinks HP will enjoy this advantage for the foreseeable future.
Cindy Shaw, an analyst with Moors & Cabot, said that while the company’s printing business is going through a “reset” period of investing to reinvigorate growth, margins have improved dramatically in other areas.
“The top line growth hasn’t been stunning but the margin improvement has been stunning,” said Shaw, who does not own shares of HP. Shaw noted that last quarter, the company’s PC division, which accounts for 30 percent of revenue, boosted operating margins to 2.8 percent, up from 1.2 percent in the year-ago quarter. Operating margins in HP’s servers and storage business rose to 9.1 percent – versus 2.9 percent in the year-ago quarter.
Also, the company announced plans yesterday to split off its hand-held device business from its PC business, in a move to help it profit from the boom in cell phones that double as PDAs.
What’s next for HP?
Shaw is bullish on HP, in part because she believes that not only is the company improving execution and margin across the board, she feels HP hasn’t begun to realize the economic benefits of restructuring, in part because the layoffs have not been completed.
But American Technology’s Wu thinks most of the restructuring benefits have been priced into the stock already, and he’s concerned about the company’s long-term growth prospects.
“At the end of the day, what is their real growth longer term? It’s probably between 5 and 10 percent. It’s hard to pay more than 15 multiple on that,” he said. HP currently trades at about 17.5 times estimated 2006 earnings.
He is also concerned about the $1.1 billion charge the company took last quarter for restructuring costs. While many analysts feel those charges are to be expected, Wu is concerned that it makes expenses look artificially low.
Both bulls and bears say that while they are impressed with Hurd’s performance so far, the company needs to articulate its long-term strategy, and soon.
“There has to be more to it than just being five different businesses under one corporate moniker,” said Chirag Vasavada, a hardware analyst for money management firm T. Rowe Price, which owns shares of HP. “The larger question is, with global GDP growing at 4 to 5 percent and IT spending that’s growing a little faster than that, will HP be a share gainer, a share maintainer or a share loser? That’s the question that investors are going to look to Mark Hurd and his team to articulate