Hewlett-Packard President and CEO Meg Whitman.
A year ago, the news about Hewlett-Packard was sounding pretty dire. The stock had plunged following an $8.8 billion write-down from its botched purchase of Autnonomy. Some observers saw the company in a perpetual turnaround. This in spite of CEO Meg Whitman efforts to explain that turnarounds take several years. Skepticism still abounded, with bears outlining why a turnaround wouldn’t work, and the rare bull arguing why Whitman wouldn’t be fired. The bearish sentiment prevailed, with HP’s stock falling to an 11-year low of $11.35 in November 2012.
I sided with the bears, comparing a strong comeback in HP with the likelihood of the Red Sox winning the World Series after its own abysmal year in 2012. The Sox, of course, did just that. And HP’s stock has gained some 95% in the past year, compared with at 22% rise in the Dow Industrials (which dropped HP’s stock from the Index in September).
On the other hand, the stock is still at half its price in early 2010. Much of HP’s rally has simply been a rebound from years of problems: Board scandals, overpriced acquisitions, rapid CEO turnover, a declining PC market, a slowdown in corporate IT spending, and less demand for printers in the age of Instagram. Many of those problems still have to be addressed.
Can HP’s stock rally in 2013 mature into a full-fledged recovery in 2014? The signs are mixed. HP’s revenue surprised Wall Street by being higher than expected – yet it still fell 3% on year. Despite cost cuts (24,500 jobs in two years and another 10,000 or so to come), operating margins fell 1.4 percentage points to 9%.
Whitman herself seems guarded about the turnaround halfway through her five-year timetable, saying it’s on track with revenue stabilizing in 2014. There remain serious challenges: The newly private Dell is threatening a price war, and the difficulty of growing revenue with a substantially smaller workforce. But there are also a few reasons why starting in 2014 HP could gain traction on the turnaround that many have doubted.
-PC shipments are finally stabilizing. Tracy Tsai, a Gartner analyst, recently said shipments of laptops and desktops will be flat in 2014 after falling an estimated 3% this quarter and falling 9% last quarter. Yes, price wars will make PCs cheaper, but also more competitive with tablets. Tablets shipments are expected to see growth slow from 22% next year to single-digit growth in 2017, according to IDC.
That could bring consolidation among PC and tablet makers, and larger, cash-rich companies like HP could increase market share. In the most recent quarter, HP said its PC shipments increased 2% while operating profit declined 16%. IDC said its share of the PC market rose to 17.1% from 15.4%. The PC price war is already being waged, and HP, Dell and Lenovo are likely to emerge with bigger shares once the shakeout ends.
-Storage and networking revenue is rebounding. One of the bright spots in HP’s recent quarter was 2% revenue growth in its enterprise group, the first rise in eight quarters. Demand for storage products acquired in the 3PAR acquistion and in networking products led the demand. Profit margins in the group, however, declined because of price competition.
While far from ideal, the enterprise group’s performance suggests HP is holding its own in a market where corporate spending has been sluggish in developed and emerging economies alike. Years of generous monetary policies are starting to foster economic growth going into 2014, which could encourage companies to improve on IT spending after years of tight budgets.
-3D printers could offer a new area of growth. To date, the emerging industry of 3D printer manufacturing has yielded more speculation than solid growth, but the promise could offer HP a longer-term way to revive growth in what has historically been its most profitable unit of business.
Right now, the field is wide open for 3D printer makers. Many of the publicly traded names are too expensive to draw suitors. But if HP builds a smart strategy in the new technology, it can build on its strengths in printing – a trusted brand, a global distribution network and existing ties to companies that may benefit from 3D printing.
–Turnaround stocks perform better when interest rates rise. Barrons recently mentioned a Credit Suisse report that looked at what stocks did best when two-year Treasury yields rose. The historical winners: companies with “a history of subpar returns on the capital they invest, but whose recent share-price momentum suggested that they were turning things around, and whose valuations still looked modest.”
That describes HP, with a PE ratio of 10 (against the S&P 500’s average PE of 20). With the Federal Reserve ready to taper off bond buying that has held down rates, HP’s stock could win extra investor interest. In the meantime, the company has $8 billion on hand to repurchase its shares.
While many of these factors could help HP extend its rally into 2014, they may not be enough to power the long-term turnaround Whitman has pledged. There is still plenty of evidence left to support a bearish argument, but at least things are looking better for HP than they were a year ago. A turnaround that seemed all but unlikely now looks like it might have a fighting chance.