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Hewlett-Packard Avoids Tech Wreck For Now

By Ben McClure

Tickers in this Article: JAVA, CSCO, INTC, DELL, HPQ

Not every IT company is getting clobbered by the lousy economy - for now, at least. Just look at Hewlett-Packard (NYSE:HPQ), which reported preliminary results Nov. 18 that beat the Street’s expectations. The news prompted some observers to call it a healthy quarter and tag H-P as a bright spot in an otherwise gloomy tech market. Indeed, H-P shares jumped 14.5% Tuesday.

Sluggish Outlook Could Signal Trouble Ahead
But in this desperate market, even the smallest sign of good news can set off a share price run-up. So, investors ought to temper their excitement. While the computing giant managed to deliver on the bottom line this quarter, a sluggish outlook could signal trouble in quarters ahead.

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Let's face it, the market didn't expect much from H-P. The stock has fallen more than 25% since September. The view, mine included, was that by now H-P's earnings would have suffered the same kind of pain felt lately by Dell (Nasdaq:DELL) and Sun Microsystems (Nasdaq:JAVA). H-P’s jump in fourth-quarter earnings has certainly eased worries. (For more, see Core Earnings Measure Up.)

Faring Well Against Tech Competition
Measured against other tech stocks, H-P looks good. Earnings were surprisingly stronger than the $1 per share analysts had expected, and quarterly sales came in at $33.6 billion, above the $33.1 billion consensus estimate. But all is not well. H-P offered full-year revenue guidance of $127.5 billion to $130 billion, well below the $135.1 billion that analysts were expecting.

Indeed, next year could be when the global slowdown really catches up to H-P, as well as to other big IT players such as Intel (Nasdaq:INTC) and Cisco (Nasdaq:CSCO), which have both cut revenue guidance for next quarter by 10% or more. IT market researcher IDC says PC sales could shrink in 2009.

How Long Can Profitability Be Maintained?
Of course, H-P might maintain profitability by cutting costs. Plans include slashing 25,000 jobs as part of integrating its $13.9 billion acquisition of Electronic Data Systems. On Nov. 17, H-P announced it was extending its one-week holiday shutdown an extra week. (For more, see What Makes An M&A Deal Work?)

But how long can that last? Eventually, falling revenue will be felt on the bottom line. Big corporate customers will start to insist on improved service-contract terms. Bad debt costs could rise as long-term contracts go bad in the wake of the credit crisis.

Buybacks Boost EPS
Buying up shares to reduce the number of shares outstanding is an alternative way to prop up earnings per share. H-P management authorized $8 billion for buybacks to be drawn from cash flow and its $14.8 billion cash pile. H-P has the balance sheet to sustain bottom-line earnings growth. But that's not a sure sign that the company can keep up profitability from its operations.

Bottom Line
Even with the prospect of a tough 2009, by historical measures H-P's beaten-down stock looks cheap. It trades at just nine times forward earnings. So far, H-P is weathering the downturn better than its competitors. But that doesn’t mean things will be rosy for the technology giant in the coming quarters. Cheap shares can get even cheaper when profits fall and prospects dim.

By Ben McClure

Ben McClure is director of McClure & Co., an independent research consultancy. Before founding McClure & Co., Ben was a highly-rated European equities analyst at London-based Old Mutual Securities. He also spent several years as a business/technology journalist at the Economist Group. McClure graduated from the University of Alberta School of Business with an MBA.

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