HP's Uppermost Problem: Its Top Line

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

≪このWindowを閉じる≫