HP’s Revenue Slides But Cost Cutting And Thicker Margins Support Shares

Hewlett-Packard (NYSE:HPQ) posted its Q2 earnings on May 22, and the PC giant’s earnings continued to reflect the challenging business environment across its business verticals. HP reported the steepest decline in revenues in recent years, as its revenues declined by 10% y-o-y to $ 27.6 billion in Q2 FY 13. However, HP delivered $0.87 in non-GAAP diluted earnings per share, exceeding its $0.80-$0.82 per share guidance by $0.05 per share.

In our earnings preview article, we stated that HP would post a division wide decline in revenues due to lower IT spending in a tepid business environment. ^[1] This earnings announcement confirmed our standing as HP reported a decline across all its divisions. However, products launched in Q1 did help HP’s enterprise group and printing division, which delivered better than expected results.

See our full analysis on HP

Outlook for 2013

The company announced significant restructuring plans in May last year as it planned to simplify business processes and lower its sales and marketing expenses. HP’s plans to reduce its workforce gained traction in Q2 as it reduced its headcount by 3500. Since its restructuring announcement, HP has reduced its workforce by 18,800 employees resulting in $2.2 billion savings in labor cost in 2013.

HP expects an increase in marketing spend driven by investments in training to support new product innovation for the remaining part of 2013. While HP expects to deliver non-GAAP diluted EPS in the range of $0.84 to $0.87, it expects GAAP diluted EPS to be in $0.56- $0.59 range, for Q3 FY13.  For the full year fiscal 2013, HP estimates non-GAAP diluted EPS to be in the range of $3.50 to $3.60 and GAAP diluted EPS to be in the range of $2.50 to $2.60.

HP’s Services Division Continues To Suffer From Lower Client Spending

The services division is the largest contributor to HP’s revenues and makes up ~40% of its estimated value. We stated in our pre-earnings article that HP’s clients were deferring from increasing their IT spend and this was affecting HP’s renewal rate in Q1. This trend continued in Q2 and HP’s services division posted disappointing results. While HP’s Enterprise services division reported an 8% y-o-y decline in revenue to $6 billion, its technology services division, which is part of the enterprise group, reported 3% decline in revenue in Q2.

Infrastructure technology outsourcing division, which makes up near 20% of HP’s value, reported a 6% y-o-y decline in revenues to $ 3.7 billion due to a contractual revenue run-off and pricing pressures. ^[2] However, HP reported triple-digit growth in revenues of 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. Converged Infrastructure built on technologies like converged storage, software-defined networking and Moonshot server will power cloud computing by seamlessly integrating big data analytics and security. We therefore, expect Infrastructure outsourcing to continue to drive HP’s services division in the coming quarter, as HP continues to increase its converged services portfolio.

Ink Advantage Program Bolsters 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 1% y-o-y to $ 6.1 billion in Q3.

HP is focusing on high-end ink market and commercial hardware rather than low end consumer hardware. HP’s newly launched Multifunction Printers (MFP) for commercial segment continued to gain traction with enterprise clients, and its share in revenue increased by 2 points. As companies upgrade to the new line of printers, we can expect MFP to bolster printer division’s profitability going forward.

In Q1 FY13, HP launched its ink advantage program that cater to enterprise clients. This program bore fruits as supplies revenues increased by 2% y-o-y to $4.12 billion in Q2. HP plans to launch a similar ink advantage program for home and small businesses in the coming quarter. These program not only increase sales, but also increases the average selling price of each hardware unit. We currently forecast printer and ink supplies price to decline from $46 in 2012 to $40 by the end of our forecast period. However, if these ink advantage programs gain traction and the average selling price of supplies were to stabilize at 2012 level, our stock price estimate can increase by 5%.

Server Division Suffers, Even As Storage Revenues Jump Due To New Launch

Server and storage division is HP’s third largest business division and makes up ~15% of its value. According to IDC, HP’s market share of 27.6% in 2012 makes it the second largest server manufacturer manufacturer in the world. ^[3]

During Q2 FY13, industrial server segment revenues decline by 12% y-o-y to $2.8 billion. Revenue declined due to poor demand across all major geographies, continued macro pressure and an intensely competitive pricing environment. 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 13% y-o-y decline in revenues to $$857 million, its converged storage offering reported 48% y-o-y increase in revenue. HP reported that it sold out of its mid-tier 3PAR storage unit and this product continues to be in high demand. In the quarter, revenues from 3PAR exceeded $1 billion run rate. We expect 3PAR converged storage solution to drive growth in revenue at storage division in the coming quarters.

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

HP’s PC and workstation division is the fourth largest division, which contributes near 30% to its revenue and makes up 15% of its estimated value. According to IDC, HP posted a substantial 23% double-digit decline in shipments in Q1 CY13.

This decline was also reflected in HP’s Personal systems division results. The revenues from this division declined by 20% y-o-y to $7.8 billion in Q2. The primary reason for decline in HP’s PC revenues was weakness in PC markets across the world. Additionally, PC prices across the industry declined due to fierce competition amongst different PC vendors. Going forward, we expect aggressive pricing across PC industry to continue, and therefore forecast HP’s desktop prices to fall.

During Q2, HP re-entered the tablet segment of mobile devices with the launch of Slate 7 at $169 price tag. We believe that this could drive revenue growth at HP’s personal systems division. According to ABI research, worldwide tablet sales are expected to surpass approximately $64 billion in 2013. ^[4] If HP can capture only 2% of this market, it will result in over a billion dollars in revenues for the company. However, competition from incumbents such as Apple is fierce, and HP will have to market its product aggressively to gain any meaningful market share.

We currently have a near $19 price estimate for HP, which is ~15% below of the current market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. See HP’s Pre-earnings article [↩]
2. Earning transcript call, May 22 2013, www.seekingalpha.com [↩]
3. Worldwide Server Market Rebounds Sharply in Fourth Quarter as Demand for x86 Servers and High-end Systems Leads the Way, Februaury 27 2013, www.idc.com [↩]
4. ABI Research: Tablet shipments expected to topple $64 billion in 2013, April 12 2013, www.zednet.com [↩]