MorningWord 5/23/14: HPQ Success or Failure?

by Enis May 23, 2014 9:11 am • Commentary

Hewlett-Packard is an impressive success story or a miserable failure.  It’s all about perspective.  Over the past 15 years, HPQ stock is flat, despite riding the global computing wave and more than doubling sales in that period.  The stock is down more than 50% from its July 2000 high, and down about 40% from its April 2010 high.  BUT, on the bright side, the stock has nearly tripled from its November 2012 low.

So what is it, success or failure for HPQ?  First off, props to Meg Whitman, who took over in September 2011 with the stock in the low 20’s and the business in free fall.  Granted, since she has taken over, sales have declined year-over-year in every single quarter, including the earnings report from last night.  But Meg didn’t choose to be in the printing, PC, servers, or technology services businesses.  She came into a terrible business situation, and the recent quarter’s mixed news reflects many of her successes against HPQ’s many business failures.

For example, even bearish analysts have been continually surprised at the relatively stable EPS and cash flow situation at HPQ, amidst a continued sales decline (-5% in 2012 and -6% in 2013, though expected to stabilize next year).  Here is the GS analyst after yesterday’s report:

Cash flow remains a critical bright spot that continues to challenge the bear case. While our concerns over HP’s long-term earnings power persists, we have been persistently surprised by HP’s cash flow management over the past year. Even excluding increased factoring of receivables, HP’s cash conversion cycle remains in the teens and cash flow has consistently outpaced guidance and expectations. Our fears over steady-state earnings power should eventually converge on the cash flow performance, but recent performance has certainly muted the near-term bear case for the stock.

One of the surprises for HPQ since Meg Whitman took over is just how much fat there was to cut.  The bear case seemed to underestimate the bloated cost structure of the company, so steady cash flow and EPS in the face of continued business pressure might be partly a reflection of extremely poor management in the decade prior to Ms. Whitman’s appointment.

None of this is to say that we view HPQ as a stellar investment at this juncture.  HPQ’s problem is similar to IBM – stuck in legacy businesses that are being threatened by more nimble competitors and a changing technology landscape (particularly more mobile and more cloud).  Management’s focus on meeting cash flow and EPS targets has perhaps been misplaced, as HPQ’s overall business model has hardly changed. This is what I wrote in a January Name That Trade post about IBM:

Moreover, the inability to grow sales is a concern for any large tech company, especially since the tech industry backdrop is so frequently changing.

Yet, IBM’s relative valuation does certainly suggest low expectations in 2014 vs. many of its peers.  The stock has had some legs ever since ORCL’s strong quarterly report in December.

Add it all up, and I am of the view that IBM is unlikely to see much of a rally in 2014, but also unlikely to see a precipitous fall.

That pretty much summarizes the HPQ situation as well.  Whitman expressed optimism that the trough in sales was finally here, and said that yesterday’s round of layoffs could indeed be the final round of restructuring.  At a 9 P/E, investors hardly expect earnings growth in HPQ.  Yet, lined up against that bull case is the very real bear case of a declining business that has sacrificed long-term sales and business development for short-term earnings and cash flow targets.

So congratulations to Meg Whitman on a job well done.  However, Mr. Hewlett and Mr. Packard, forward-looking technologists that they were, would not be optimistic about HPQ’s prospects when financial targets hold more importance than building the business.