Weak Business Environment Weighs On HP’s Q3 Earnings

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Hewlett-Packard (NYSE:HPQ) posted its Q3 earnings on August 21. Revenues continued to reflect the challenging economic environment across business verticals. While HP’s revenues declined by 8% y-o-y to $27.2 billion, it delivered $0.86 in non-GAAP diluted earnings per share.

In our earnings preview article, we had said that HP will continue to post a division-wide decline in revenues due to lower IT spending. [1] The earnings announcement confirmed our belief as HP reported a decline in revenues across divisions. However, we are encouraged by the results of some of its divisions such as printing, enterprise services and converge storage.

See our full analysis on HP

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New Signings Fillip Enterprise Service Division

The services division is the largest contributor to HP’s revenues and makes up ~40% of its estimated value. While discretionary IT spending continued to reel due to the tepid business environment, HP did report an improvement in signings as the renewal rate increased during the quarter. The company now expects enterprise services’ full year revenues to decline by 8%-9%, less than 11%-13% indicated in the Q2 earnings call.

While HP’s enterprise services division reported an 8.5% y-o-y decline in revenue to $5.8 billion, its technology services division, part of its enterprise group, reported a 7% decline. Additionally, the infrastructure technology outsourcing division, which makes up near 20% of HP’s value, reported a 7% y-o-y decline in revenues to $3.7 billion due to a contractual revenue run-off and pricing pressures. [2] However, HP reported double-digit revenue growth in its strategic enterprise services such as cloud, security and big data. We believe that cloud services are potentially the biggest new revenue source for HP in 2013.

Hardware Unit Sales Surge At Printing and Ink Cartridge Division

The printer and ink cartridge division is HP’s second largest division and makes up ~20% of its value. The printer division did report better-than-expected results as its revenues declined by 4% y-o-y to $ 5.8 billion in Q3. HP is focusing on the high-end ink market and commercial hardware rather than low-end consumer hardware. While consumer hardware unit sales grew by 2% y-o-y, its commercial hardware unit sales increased by 12% y-o-y. As a result, total unit shipments grew 5% y-o-y.

Additionally, its business initiatives like ink advantage and new products like Officejet Pro X continue to take hold with strong customer adoption. These initiatives not only increase sales but also increase the average selling price (ASP) of each hardware unit. We currently forecast printer prices to decline from $155 in 2012 to $145 by the end of our forecast period. However, if these ink advantage programs gain traction and the average selling price of printers stabilize at 2012 level, our stock price estimate could see upside.

Server and Storage Division

The server and storage division is HP’s third largest business division and makes up ~15% of its value. While HP continues to lead the server global shipment market with 30% share, it reported a 13.6% decline in the number of server units shipped during the quarter. [3]

During Q3 FY13, the industrial server segment revenues declined by 11% y-o-y to $2.8 billion due to poor demand across major geographies, continued macro pressure and an intensely competitive pricing environment. Additionally, HP’s hyperscale server also reported a double digit decline. HP recently launched its hyperscale Moonshot server to bolster its reeling industrial standard server division. We expect Moonshot will drive revenue growth at HP’s server division going forward.

Although the storage division reported a 10% y-o-y decline in revenues to $833 million, its converged storage offering reported 37% y-o-y growth. Its mid-tier 3PAR storage unit continued to gain traction and reported double digit growth in sales. As more companies adopt cloud storage, we expect 3PAR converged storage solution will drive revenue growth at its storage division.

PC and Notebook Division Continues To Reel Due To Secular Downtrend In PC Markets

The PC and workstation division is the fourth largest division, which contributes near 30% to HP’s revenue and makes up 15% of its estimated value. According to IDC, PC shipments declined by 11.4% in Q2 CY13. [4]

This decline was also reflected in HP’s personal systems division’s performance. The division’s revenues dropped by 11% y-o-y to $7.7 billion during the quarter. Additionally, the company also reported that continued pricing pressure and currency headwinds drove operating profit down by 1.7% y-o-y to $228 million. Going forward, we expect aggressive pricing across the PC industry to continue and forecast HP’s desktop prices to fall as well.

We are in the process of updating our model. We presently have a $18 price estimate for HP, which is ~20% below the current market price.

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Notes:
  1. See HP’s Pre-earnings article []
  2. Earning transcript call, August 21 2013, www.seekingalpha.com []
  3. IDC Q2 Server Data, August 13 2013, www.crn.com []
  4. Lenovo Overtakes HP as the Top PC Vendor While U.S. Shipments Stabilize in the Second Quarter of 2013, July 10 2013, www.idc.com []