While rivals such as Dell are growing, Carly &
Co. is squeezing profits out of lackluster revenues, and that leaves
lots of investors uneasy
Ten months into digesting a highly
contentious acquisition, investors are beginning to raise the bar on Palo
Alto (Calif.)-based Hewlett-Packard (HPQ ), which acquired
Compaq Computer in May, 2002. Their expectations may be too high: Most
concede that embattled CEO Carleton S. Fiorina has delivered on promised
cost savings -- $2.5 billion worth, more than two years ahead of plan,
says HP -- but shareholders are now demanding top-line improvement, too.
However, for the fiscal first quarter, HP reported below-par
revenues of $17.9 billion, about $600 million less than analysts had
forecast. Earnings per share of 29 cents beat expectations by a penny, but
the disappointing revenues prompted investors to sell off shares by 15%,
to about $15. The stock has since rebounded to $16, and HP is blaming the
U.S. market's ongoing weakness for last quarter's shortfall. Some analysts
are sympathetic. "At this point, 2003 isn't about the top line for most
everyone," notes Chris Jarvis, Advest associate director for research.
LOSING GROUND? Though it's
possible that HP is in the same boat as other tech concerns suffering
through a protracted slump, investors are fearful that it's losing ground
to competitors. "You have to bring in both revenues and have good margins.
One without the other just isn't that valuable," says Morningstar analyst
Joseph Beaulieu, who thinks the stock would be fairly valued at $17.
Neither Beaulieu or Jarvis owns HP shares.
Wall Street is
essentially split on the stock, with 10 of the 19 analysts who follow HP
rating it a buy or strong buy, and the other nine giving it a hold rating.
The stock is relatively cheap at 11 times 2004 earnings, especially
compared to rivals Dell Computer (DELL ) and IBM (IBM ). Dell trades at 27
times 2004 earnings, and IBM has a p-e of 16. The top competitor to its
printer business, Lexmark (LXK ), now $62, trades
at a p-e ratio of 17 times 2004 earnings expectations.
Yet even at
the current relatively low price, HP shares may not be compelling enough
to new investors. Most analysts voice caution about the merger integration
thus far. "There's the possibility that demand picks up, and they will
deliver on revenue growth," Beaulieu says. "Question is whether you want
to bet your money on it. From what I've seen, the potential rewards don't
outweigh the risk."
WIDESPREAD
WEAKNESS. With this latest quarter of mixed signals --
better-than-expected earnings and disappointing revenues -- it's likely
too early to proclaim the merger a success. And that uncertainty, coupled
with continued weakness in technology, could keep the stock price stuck in
neutral.
A close look at the different pieces of HP's business
last quarter shows weakness across nearly all major divisions -- personal
systems (PCs and consumer business), enterprise systems (servers and
storage), and information-technology services (maintenance and support).
Only revenues at the stalwart printing and imaging segment improved from
year-ago levels, up 9.4%, to $5.6 billion, which represents 31% of the
quarter's total sales. However, an HP spokesperson notes that four out of
five divisions were profitable during the quarter, and the loss-making
enterprise business is on track to be in the black in the second half.
Despite its profits, HP's revenue weakness comes as competitor
Dell posts overall improvement in the area. While HP's year-over-year
sales fell 8.8% in the quarter, Dell's revenues gained 20.8%. It's
encouraging that HP reversed several quarters of losses for its
personal-systems division, but revenue for that segment declined 18.6%, to
$5.1 billion year-over-year. Meantime, Dell's desktop-computer revenues
rose 16%, and notebook revenues gained 22%.
UNJUST COMPARISON? Just as worrisome, HP's
service-business revenues declined 9.4%, while IBM, with help from its
recent acquisition of PricewaterhouseCoopers Consulting, saw a 16.7%
revenue rise in services in its fourth quarter. Dell had a 22.8% revenue
increase for its relatively small services business.
In the
important Americas market, HP's quarterly revenues fell 7% from the
preceding quarter, whereas IBM and Dell both saw increases, says A.G.
Edwards analyst Shebly Seyrafi. For the same region, Dell saw a 14.4%
gain, and IBM saw 3.1% increase in their most recent quarters. HP points
out that revenue comparisons for its fiscal first quarter are against the
fiscal fourth quarters of IBM and Dell, and the last quarter is often a
company's strongest. Seyrafi doesn't own HP shares, and his firm has no
banking relationship with HP.
Many analysts worry about its
ability to increase revenues as Dell stays strong in PCs, gets stronger in
its enterprise business, and starts moving in on the printer business.
Most analysts figure HP can turn in mid-single-digit revenue growth in the
next couple of years. Dell's revenue growth, meanwhile, will be more in
the ballpark of low double-digit increases, largely on strength in its
expanding server and storage businesses. HP says it expects revenue gains
of 2% to 4% in fiscal 2003 and 10% annual growth over the long term. "But
it's not going to be much of an outperformer in our opinion," says Bob
Takazawa, vice-president and portfolio manager at Chicago-based CastleArk
Management.
"VERY POSITIVE SIGNS."
Takazawa, who owns Dell shares but not HP, says so far, the HP-Compaq
merger doesn't impress him: "This quarter suggests that we shouldn't be
scared at all from a Dell standpoint." He reasons that even when
corporations start to spend more on technology products, HP will still
have to fight it out with more dominant businesses that presumably will
benefit from the same cyclical tailwind. When the recovery gets under way
in earnest, "this one falls to the middle or lower side of the pack."
notes Takazawa.
Others expect the merger will prove fruitful once
the overall environment improves. In the short term, Victory Capital
Management's Walter Henry was also disappointed by revenues, but he
figures that the stock is trading just above the value of the imaging and
printing business alone, which he pegs at $14 or more. "They're certainly
showing very positive signs on managing the business in a difficult time,"
Henry says. As of Sept. 30, Victory owned some 9 million shares of HP. The
shares are Henry's biggest holding in the computer and office-equipment
area.
Yet in the near term, buying HP stock remains risky. At some
point, investors will be able to see what ails revenue growth: The tech
malaise or the Compaq merger itself. Analysts expect the next quarter,
ending Apr. 30, to be telling since the two outfits will have been
combined for nearly a full year by then. And in that time, an overall
pickup in IT spending could be under way. But until then, investing in HP
is no sure thing.
Tsao
covers financial markets for BusinessWeek Online in New York
Edited by Beth
Belton