Did Investors Overreact to HP's Lackluster First-Quarter Report?

Leo Sun, The Motley Fool

Updated Mon, Mar 4, 2019, 8:47 PM

Shares of HP (NYSE: HPQ) recently plunged after the PC and printer maker posted a mixed first-quarter report. Its revenue rose 1% annually to $14.7 billion, missing estimates by $150 million and marking its slowest growth rate in 10 quarters. HP's non-GAAP net income rose 1% to $0.8 billion, and its earnings per share, buoyed by buybacks, climbed 8% to $0.52 per share and matched analysts' expectations.

HP expects its non-GAAP EPS to rise between 4% and 10% annually during the second quarter, while the consensus forecast calls for 10% growth. For the full year, the company expects its EPS to rise 5% to 10%, versus expectations for 9% growth.

An astonished man looks at a computer monitor.

Image source: Getty Images.

HP didn't provide any top-line guidance, but analysts expect its revenue to stay roughly flat during the second quarter and rise less than 1% for the full year -- indicating that most of its earnings growth will come from lower operating expenses and buybacks.

Those numbers were disappointing, but are investors overreacting and underestimating HP's long-term value? Let's take a closer look at its first-quarter numbers to find out.

The key numbers

HP generated two-thirds of its revenue from the personal systems (PCs and workstations) business during the third quarter. The rest came from its printing business. The growth of both units hit a brick wall during the first quarter:

Business Unit	Q1 2018	Q2 2018	Q3 2018	Q4 2018	Q1 2019
Personal systems	15%	14%	12%	11%	2%
Printers	14%	11%	11%	9%	0%
Total	14%	13%	12%	10%	1%

Year-over-year revenue growth. Data source: HP quarterly reports.

HP's personal systems revenue grew as its commercial and consumer segments posted 3% and 1% year-over-year growth, respectively. However, its total shipments fell 3%, due to a 1% dip in notebooks and 8% drop in desktops.

HP offset those declining shipments, which can be attributed to sluggish upgrades and the ongoing shortage of CPUs, with higher prices -- which indicates that it still has solid pricing power. HP expects CPU supplies to improve in the second half of the year, and for prices for its other key components, like memory chips, to remain favorable.

Image source: Getty Images.

Meanwhile, the printing business's total hardware shipments rose 3% annually, with 4% commercial growth and 2% consumer growth, but its higher-margin supplies segment revenue fell 3%. As a result, higher hardware shipments failed to boost the unit's revenue growth into positive territory.

HP attributed the softness of its supplies business to slower demand in its EMEA (Europe, Middle East, and Africa) region, lower orders in its Tier 1 and Tier 2 channels, and competition from cheaper generic supplies from online retailers.

HP doesn't expect the situation to improve significantly this year, and projects that its supplies revenue will fall 3% for the full year (compared to its prior guidance for flat to positive growth) -- which is worrisome because the unit generates much higher margins than its hardware business.

But over the long term, its printing unit should stabilize as the company expands its industrial 3D printers business and leverages its takeovers of Samsung's printing unit and office equipment dealer Apogee to widen its moat in the enterprise market.

However, HP still expects currency headwinds -- which reduced its reported revenue growth by 70 basis points during the quarter -- to persist and throttle its sales growth in the higher-growth EMEA and Asia-Pacific regions.

Expanding operating margins and strong cash flows

HP will face a lot of top-line challenges this year. However, its operating margins still expanded sequentially and annually during the first quarter:

Business Unit	Q1 2018	Q2 2018	Q3 2018	Q4 2018	Q1 2019
Personal systems	3.6%	3.8%	3.9%	3.8%	4.2%
Printers	15.8%	16%	16%	16.1%	16.2%

Operating margins. Data source: HP quarterly reports.

HP attributed its higher personal systems operating margin to a better pricing and product mix, and its expanding printing operating margin to tighter cost controls, which offset the impact of its lower gross margin.

However, we should note that HP's printing business generated more than double the operating profits of its personal systems unit during the first quarter. Therefore, soft demand for HP's higher-margin printing supplies remains a major long-term threat to its bottom-line growth.

HP expects to generate "at least" $3.7 billion in free cash flow (FCF) this year, which would be a decline from $4.2 billion in 2018 but should give it ample room for buybacks and dividend hikes. It already spent nearly $1 billion on buybacks and dividends in the first quarter, and those shareholder-friendly moves should continue for the foreseeable future.

The valuation and verdict

HP faces some tough near-term challenges, but its stock trades at less than eight times forward earnings with a forward dividend yield of 3.3%.

Its PC shipments should rebound as it resolves its CPU shortage issues, while the printing business should improve as the company integrates and leverages its recent acquisitions. And buybacks and dividends should set a floor under the stock. Therefore, buying HP following its post-earnings plunge could be a smart long-term move for conservative income investors.

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