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The Case for Hewlett-Packard in the Post-PC World

Jun 13, 2014

The Pro: Robert Landry, portfolio manager, USAA Investment Management Co.

The Pick: Hewlett-Packard

The Case: Last month Hewlett-Packard’s chief executive Meg Whitman announced that she’d be firing up to 16,000 employees. That’s on top of an additional 34,000 workers.

Revenues for HP, the elder statesman of Silicon Valley, have fallen for 11 consecutive quarters. In fact, the company's trailing 12-month revenues are about the same as they were six years ago.

The company still earns a large portion of its revenue from older fare – think personal computers, and printers – at a time when cloud computing and mobile tablets are becoming the focal points of innovation. And Whitman is in the middle of a 5-year turnaround effort.

Nevertheless, investors have driven Hewlett-Packard stock up 37% over the past year.


Why? Revenues may be down, but profits have been above $1 billion for the last six quarters. (Total expenses are also down over the last two quarters.)

Plus, USAA Investment’s Bob Landry thinks some investors don’t properly appreciate HP's aptitude for change. “The biggest misconception is that people believe the company is an old dog that can’t be taught new tricks. That they can’t pivot from being a legacy hardware company to focusing more on enterprise services and software.”

It's not as if Hewlett-Packard doesn't have a hand in state-of-the-art technology, like “the Machine.” Cooked up in HP Labs, the Machine is sort of a post-cloud computing system that will be able to deal with huge amounts of data.

Whether Hewlett-Packard can actually evolve into the company Whitman, and her shareholders, want it to become remains to be seen.


While reducing headcount by 50,000 cannot be good for morale (or perhaps for attracting top talent), the job losses from older parts of the company that have been struggling, says Landry.

“A lot of these people were tied to more legacy products that weren’t growing,” he says. “They’re trying to right size the company.”

This is part of the company’s larger to invest in growth areas, including tables, cloud computing, IT management software and big data.

And restructuring has helped operating margins, which have been positive for the last three quarters, after going negative for over a year.


“Hewlett-Packard is a significant cash flow generator,” says Landry. In other words, after they meet all their obligations and make their capital investments, they still have cash left over that gives them financial flexibility. With a free cash flow yield of 12%, “management has pledged to return at least 50% to shareholders through buybacks and dividend increases,” Landry says.

For instance, last quarter Hewlett-Packard earned $3.0 billion in free cash flow, while returning $1.1 billion to shareholders.

Meanwhile, the stock is trading at a pretty reasonable valuation. With a price/earnings ratio of 8.8, based on estimated profits (per Bloomberg), Hewlett-Packard is a cheaper option than IBM and Xerox .

One reason why Landry likes Hewlett-Packard's turn toward the software and networking aspects of its business is that those sectors are high margin business. Last quarter, operating margins on its software business was 19.2%, second only to printing. Enterprise (which includes networking) was third at 14.4%.

What if the plan doesn’t work?

While Landry is patient with Hewlett-Packard, and believes in its story, he says he eventually needs to see some revenue growth.

“If revenue growth doesn’t come throw, if it falls short of expectations, that would be a problem,” says Landry.

And last quarter proved problematic for some of Hewlett-Packard’s businesses, even its non-legacy ones. Software revenue was unchanged year-over-year, while the enterprise group fell by 2%.

One sector that did see gains (7%) was its personal systems section (which includes notebooks, desktops and workstations). Of course personal systems is a pretty low-margin business.

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