Strong service results and cost cutting lifts Hewlett Packard (HPQ)

Hewlett-Packard (HPQ) reported fiscal third-quarter results that were largely in-line with expectations thanks strong performance from the services unit and effective cost management. The world’s largest PC maker suggested that business is beginning to stabilize and they expect to be an early beneficiary of an economic turnaround.

Revenue for the quarter declined 2% to $27.45 billion. Every business reported steep double-digit declines versus a year ago except the services unit, which increased revenues 93% from a year ago before it had acquired EDS. The way HPQ reports their service unit results makes it difficult to determine how the old EDS outsourcing business is performing, but the 15.2% operating profit is an encouraging sign.

Lower selling prices weighed on revenues in the PC unit as well as the servers and storage division, but strength in areas such as enterprise hardware spending suggest that corporate IT spending may have bottomed. Still concerning, however, are the printer and software businesses, both of which saw sales decline versus last year and last quarter.

Operating profits were mixed by business unit, with improvements in service’s operating margins offsetting declines from servers and PCs. The company generated nearly $4 billion in operating cash, a $500 million improvement from a year ago, as the company benefits from good management of its working capital, particularly inventory. The only red flag with HPQ’s cost cutting is that R&D is only 2.4% of sales, less than half the level five years ago and significantly less than rival IBM’s 6.2% of sales.

The shares declined today as near-term expectations had gotten a bit frothy for HPQ’s upside. Still, the company has successfully managed through the downturn and gained market share in the process. HPQ is trading at 11.5 times forward earnings, a 31% discount to the S&P 500.
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Peter J. Lazaroff, Investment Analyst