EUR 850.00 For Business Accounts Only

Morningstar | HPQ Updated Forecasts and Estimates from 06 Sep 2018

After taking a fresh look at HP and incorporating the firm's fiscal third-quarter earnings, we are raising our value estimate to $23 per share from $22. HP's navigation through recent industry turbulence is commendable; however, potential long-term headwinds in high-uncertainty HP's core operating segments provide the foundation for our no-moat and negative moat trend ratings, which we maintain. We remain skeptical of HP's long-term growth strategy to adequately offset challenges in core business segments. With the shares trading slightly higher than our fair value estimate, we caution investors to wait for a larger margin of safety before investing.

HP's third-quarter results exceeded guidance by delivering year-over-year revenue increases of 12% for personal systems and 11% for printing. Notebooks and desktops both grew revenue by double digits, and operating profits for personal systems increased to 3.9% of revenue. The personal systems segment enjoyed higher average selling prices and a favorable product mix as HP continues to gain share in premium computers. The printing business' revenue growth came at the sacrifice of operating margins, which decreased 130 basis points to 16.0%.  Operating margins were dragged down by investments in the A3 and 3D printing markets. Consolidated gross margins declined year over year to 18.4% and operating margins came in at 7.4% for the quarter.

Management increased its guidance for fourth-quarter earnings per share and said shareholders should expect a return up toward 75% of HP's free cash flow. We expect sequential top-line growth for both business units with operating margin compression. For fiscal 2019, we expect a considerable slowdown with marginal organic revenue growth as HP's competitors respond with new PC products and printing services becomes more cost-competitive.

Although we expect HP to remain a leader in the personal computer and printing markets, we opine that difficult long-term business environments should temper sustainable growth opportunities. Industry shifts toward using mobile devices as computer supplements or replacements, PC hardware refresh cycles less dependent on operating system launches, and fewer printing tasks being performed for economic and environmental reasons may create headwinds for HP. We believe that HP's growth initiatives will expand its market share within the PC and printing industries as consolidation occurs, but we expect cost competitiveness among the remaining vendors to limit potential upside.

We believe personal computer purchases will contract as more households primarily use smartphones for computing tasks and as cloud-based software upgrades delay the impetus to upgrade computer hardware. HP's personal systems business, containing notebooks, desktops, and workstations, yields a narrow operating margin that we do not foresee expanding. The company's growth focus areas of device-as-a-service, or DaaS, retail point of sale systems, and expanding its gaming and premium product offerings should help stem losses from its core expertise of selling basic computer systems. Contractual service offerings like HP's DaaS are alluring to businesses since IT teams can offload hardware management, receive analytics to proactively mitigate computer issues, and pay monthly instead of facing unpredictable large capital expenditures. However, we caution potential upside limitations with HP's plan to combat the competitive PC market since. In our view, the big three PC vendors may provide similar DaaS offerings. Customers adopting HP only due to services and retail point of sale systems could be hampered by SaaS and a bearish brick-and-mortar outlook, while premium and gaming machine may become cost competitive.

HP's contractual managed print services, in additional to focusing on graphics, A3, and 3D printers are moves in the correct direction, but the overarching trend of lower printing demand should stymie revenue growth within printing, in our view. The company is innovating in a mature market, but we believe competitors can mimic HP's successes or cause price disruption. HP's scale may enable success within the 3D printing market; even though HP is late entrant, its movement into printing metals could cause customer adoption. We posit that HP can benefit from the A3 and graphics markets in the short-term, but caution that operating margins may compress as incumbent vendors lower prices. Though HP's expansion efforts may lead to short-term gains for its printing business, our largest concern with the printing market is the overall trend of screen reading replacing printed pages, and we do not believe HP's initiatives can offset the macro trend.