HPQ Earnings: PC Sales Props Up Revenues

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Hewlett-Packard (NYSE:HPQ) posted its third quarter earnings for fiscal year 2014 on 20th August. In line with our expectation, HP’s revenues grew moderately by 1% year over year to $27.6 billion. [1] However, as most of the growth was due to sale of hardware, the GAAP operating margins for the company declined by 150 basis points year over year to 5.3%. As a result, the company delivered $0.52 in GAAP diluted earnings per share, down 27% from the year-ago quarter. The revenues continued to reflect the challenging economic environment across some of its business verticals. While services revenues declined by 6% year over year to $5.59 billion, the printing revenues declined by 4% to $5.59 billion. However, personal systems and enterprise group revenues, buoyed by improving markets and share gains, grew by 12% and 2%, respectively.

See our full analysis on HP

Outlook for Q4 and 2014

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For Q4 FY14, HP estimates non-GAAP diluted net EPS in the range of $1.03 to $1.07, and GAAP diluted net EPS in the range of $0.83 to $0.87. For fiscal 2014, HP estimates non-GAAP diluted net EPS between $3.70 and $3.74 and GAAP diluted net EPS between $2.75 and $2.79. Fiscal 2014 non-GAAP diluted net EPS estimates exclude after-tax costs of approximately $0.95 per share, related primarily to the amortization of intangible assets and restructuring charges. [2]

Shipment Sales Spur PC Division

HP’s PC and Workstation division is the fourth largest division, contributing nearly 30% to its revenue and 9% of its estimated value. It is evident that the PC demand rebounded globally as the shipments stabilized, in line with Gartners preliminary results. [3] HP’s personal systems division outperformed the industry as both the number of shipments and revenue grew. The company reported 13% growth in total units shipped during the quarter, buoyed by a 18% increase in notebook and 6% growth in desktop shipments. Furthermore, commercial and consumer revenues were up 14% and 8% respectively. As a result, the company reported 12% year-over-year growth in revenues to $8.6 billion against the backdrop of a marginal 0.1% growth in PC units in the second calendar quarter. Operating profit also improved by 0.9% year over year to $346 million or 4% of revenue. The surge in PC sales suggests that HP’s clients are looking to refresh their aging installed base, and we believe that this will augur well for the company in the coming quarters.

HP Service Revenues Continue To Suffer

The services division makes up 32% of HP’s estimated value. HP’s enterprise services division reported a 6% year-over-year decline in revenue to $5.59 billion, primarily due to key account revenue run off and softness in new signings for the quarter. Within this segment, the infrastructure technology outsourcing division reported a 8% year-over-year decline in revenues to $3.49 billion, due to a revenue run-off of lapsed contracts and pricing pressures. Furthermore, its application and business services revenues declined by 4% year over year to $2.09 billion, primarily due to softness in the applications business.

Enterprise Group Buoyed by ISS

The Enterprise Group is HP’s second largest business division and makes up 20% of its value. Notably including HP’s Industry Standard Servers (ISS), the division reported 9% year-over-year growth in revenues to $3.09 billion. The primary driver for this growth was average unit prices, which grew double digit year-over-year. However, the company continued to experience decline in its business critical systems division as revenues declined by 18% year over year to $233 million.

The storage division revenues declined 4% to $796 million as revenues for traditional systems declined by 14%. However, its converged storage grew by 9% and mid-tier 3PAR storage unit continued to gain traction. As more companies adopt cloud storage, we expect 3PAR and converged storage solution will drive revenue growth at its storage division.

Pricing Pressure Drags Printing and Ink Cartridge Division

The printer and ink cartridge division is HP’s third largest division and makes up ~17% of its value. The printer division reported 5% year-over-year decline in revenues to $5.59 billion in the quarter as supplies revenues declined by 5% to $3.7 billion. The primary reason for decline in supplies revenue was inventory correction from the consolidation of U.S. retailers, which may also suggest some softness in demand in the future. Furthermore, a 5% year-over-year growth in the number of hardware units shipped accentuated the decline in Average Selling Prices and revenues. While the commercial hardware unit sales declined by 2%, consumer hardware unit sales declined by 6% year over year.

Software Division Revenues Flat lines

The software division makes up 10% of HP’s estimated value. While the company reported 16%decline in license revenues, service revenues grew by 1%. The primary reason for decline in license revenue was shift in user preference for software as a service (SaaS), revenues for which grew by 8% during the quarter. As a result, its software division revenues declined by 5% year over year to $959 million. Furthermore, HP reported double-digit revenue growth in its cloud, security and big data services. We believe that cloud services are potentially the biggest new revenue source for HP in FY2014. [4]

We are in the process of updating our model. We presently have a $25.04 price estimate for HP, which is 28% below the current market price.

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Notes:
  1. See HP’s Pre-earnings article []
  2. 8-K []
  3. After Two Years of Decline, Worldwide PC Shipments Experienced Flat Growth in Second Quarter of 2014, July 9 2014, www.gartner.com []
  4. Earning transcript call, August 20 2014, www.seekingalpha.com []