HP Earnings Preview: Revenues To Decline As Challenging Business Environment Persists

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Hewlett-Packard (NYSE:HPQ) is due to release its Q2 earnings on May 21st. (Fiscal year end with October.) In the previous quarter, HP’s revenues declined by 5% year over year (2% in constant currency) to $26.8 billion. Furthermore, the company delivered $0.73 in GAAP diluted earnings per share, marginally down from the year-ago quarter. A tough business environment continued to affect its profitability across most geographies and verticals. The decline was further accentuated by the cross currency headwinds as dollar was strong viz-a-viz other currencies.

We believe that these factors are still at play and continue to impact HP’s revenues and profitability. Therefore, we expect that weak enterprise demand for HP’s services will continue to impact HP’s revenues across its services business divisions in Q2. However, the company’s leadership in the hardware segment across printers, PCs servers will continue to boost revenues.

See our full analysis on HP

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Outlook for Q2 and 2015

For Q2 FY15, HP estimates non-GAAP diluted net EPS in the range of $0.84 to $0.88, reflecting an estimated currency impact of $0.09. It expects GAAP diluted net EPS in the range of $0.57 to $0.61. For fiscal 2015, HP has revised its guidance downwards due to currency headwinds.  It estimates non-GAAP diluted net EPS between $3.53 and $3.73 and GAAP diluted net EPS between $2.03 and $2.23. [1]

Trends To Impact Revenue Growth

Demand for IT services continues to main weak, especially in the European region that is in the midst of economic turmoil. Furthermore, the continuous changes in the technology domain, especially due to new products and category innovation, define and redefine the landscape. As a result, well-funded startups are disrupting the business practices of incumbents. Due to this competition, clients have become demanding and are seeking greater performance, better functionality, and more platform independence at the lowest price point possible.

HP is plagued by these trends, which is also visible in its quarterly results. With the  Q2 release, we expect the company to post a marginal decline in revenue across most of its services divisions. However, we expect revenues from the PC hardware division to grow marginally as the company will be able to leverage the unpopularity of Lenovo, which was plagued by pre-installed software that made the PCs susceptible to hacking. For most of the other divisions, we project a mid-single-digit decline in revenues.

Printer Division

HP’s printer and ink cartridges division is its largest division and contributes nearly 27% to its estimated stock value. HP leads the worldwide hardcopy peripheral market with a market share of over 40%. It also leads the large format printer industry with 41% share in 2014. [2] To some extent, resilience in laser hardware sales has offset the decline in total sales. However, this trend seems to have faltered in Q1 as Lexmark, which is one the biggest laser printer manufacturer in the U.S., posted sub-par growth in laser hardware and supplies sales. HP continues to target the high-end ink-jet market and commercial hardware, rather than low-end consumer hardware. This should augur well for HP as most of the revenue growth was in the high-end laser sales in Q1. While the tough pricing environment will continue to negatively impact supplies revenue, higher unit sales (at lower price points) will offset this decline for the company to post minor growth in revenues.

HP Services and Software Divisions

HP’s services and software divisions collectively account for nearly 29.5% of the company’s value, in our estimation. During the last quarter, HP reported a decline across both services and software divisions as the business environment was tepid. The business environment continues to be challenging, and considering the revenue run off of lapsed contracts and pricing pressures in the last quarter, we expect that the decline in services revenues will be more profound as compared to the previous quarter. Additionally, the company reported softness in new contract signings in the last quarter, and in this earnings announcement, we’ll be closely watching HP’s new contract signings. Furthermore, we are also monitoring the renewal rate and pricing for HP’s technology and application services as both these metrics have been trending lower over the past few quarters, and have negatively impacted revenue growth. However, HP continues to report double-digit growth in revenues of its strategic enterprise services such as cloud, mobility, security and big data. Therefore, we expect converged cloud services to be the key driver for services revenue during this quarter.

Server & Storage Division

The server and storage division is HP’s third largest business division, making up 17.8% of its value. In Q4 CY14 (which corresponds to HP’s Q1 FY14 as the company has year ending in October), HP’s Industry Standard Server (ISS) division reported a 7% year-over-year growth in revenues, primarily due to double-digit increases in ISS’s ASPs as the Gen9 ProLiant server drove margins. Going forward, the combination of Gen9 and the refresh cycle of server should drive growth in the remainder of 2015. We expect the company to post growth in server shipments, which should offset the decline in revenues from business critical systems. We expect the division to report moderate gains in revenues in Q2.

PC Shipment And Revenues To Grow, Albeit At A Slower Pace

HP’s PC and workstation division is the fourth largest division, contributing nearly 30% to its revenue and 14% of its estimated value. According to Gartner and IDC, worldwide PC shipments experienced decline of over 5% in the first quarter of 2015 as customer await the release of Windows 10 in June. [3] However, market leaders gained market share over the laggards. HP strengthened its position as its market share improved from 16% in Q1 2014 to 17.3% in Q1 2015. We believe that, on the back of new launches it had undertaken in the previous quarters, HP’s shipment will continue to boost its top-line in Q2.

We currently have $30.35 price estimate for HP, which is approximately 10% below the current market price.

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Notes:
  1. 8-K []
  2. Worldwide Large Format Printer Shipments Grew 3.5% Year Over Year in 2014, According to IDC, February 19 2015, www.idc.com []
  3. Gartner and IDC agree: PC shipments fell at least 5% in Q1 2015 as Windows XP replacement cycle starts to fade, April 9 2015, www.venturebeat.com []