On Tuesday morning, Goldman Sachs Group, Inc. (NYSE:GS) analyst Bill Shope downgraded Hewlett-Packard Company (NYSE:HPQ) from hold to sell, with a price target of $16, based on a $3.26 EPS estimate for FY 2013. Shope primarily harped upon weakness in the PC industry, which may depress not only unit shipments, but also prices and margins. That said, he believes that Hewlett-Packard Company (NYSE:HPQ)’s other major divisions could face trouble as well, calling out enterprise hardware, services, and printing. Combined, these factors could mean that earnings will continue to decline for Hewlett-Packard Company (NYSE:HPQ) even after 2013.
However, Mr. Market already recognizes the challenges faced by Hewlett-Packard Company (NYSE:HPQ) in the various businesses Shope mentioned in his report. That’s why Hewlett-Packard Company (NYSE:HPQ) shares still trade for less than seven times Shope’s very conservative EPS target, despite having doubled since late November.
Unlike Shope, I am confident that CEO Meg Whitman will turn around Hewlett-Packard Company (NYSE:HPQ)’s performance over the next few years. Indeed, the business has started to show signs of improvement. While PCs will remain an area of weakness, the PC business now represents less than 10% of HP’s profit (whereas it still generates 25%-30% of rival Dell Inc. (NASDAQ:DELL)‘s profit). The printing business is already seeing improved profitability, and while the enterprise hardware and services businesses remain works in progress, they are likely to bottom this year.
Printing margins are growing
HP is the dominant player in printing globally, and will remain so for the foreseeable future. However, the printing business has stagnated in the past few years, as the growth of mobile devices has led people to print fewer documents and photos. Furthermore, the “razor and razor blades” printer pricing model has broken down, as savvy consumers have turned to generic ink to save money. This has crimped margins, as many printers are sold at a loss in the hope of generating a steady stream of profitable ink sales in the future. Lastly, the strong yen has raised the cost of printer components sourced from Japan, particularly the print engines for HP LaserJets, which are built by Canon Inc. (ADR) (NYSE:CAJ).
Most of these headwinds have dissipated in recent quarters, which Shope seems to have discounted. The yen has declined by roughly 20% against the dollar since October, which (as I have argued on numerous occasions) will provide a significant tailwind to printing margins this year as component prices drop. Others have finally begun to take notice of this trend: Morgan Stanley (NYSE:MS) analyst Katy Huberty cited better printing margins as one major reason for her recent upgrade of HP.