Hewlett-Packard Company (HPQ): Waiting for a Signal

Where will earnings go?
The biggest risk for long-term HP investors is that declining revenue will overshadow the company’s cost cuts and lead to lower earnings. (For reference, FY13 will be the second year in a row that HP has experienced declining revenue and earnings.) On the other hand, if HP can grow earnings next year, it will dispel many of the bears’ worst fears.

Fortunately, I expect HP to hold EPS flat or better in FY14. While HP has started to see significant benefits from its cost-cutting in the past quarter or two, this restructuring savings will probably accelerate next year. At the beginning of FY13, only 11,700 positions had been eliminated, whereas headcount reductions will reach 26,000 by the end of the fiscal year. Real estate and other non-payroll savings will also probably grow next year.

On the flip side, Hewlett-Packard Company (NYSE:HPQ)’s revenue has slid by approximately by 8% this year but will probably decline by a smaller amount in FY14. The lower base revenue will create an easier comparison. In addition, the end of Windows XP support next April — which will stimulate higher PC replacement demand — and new products such as Moonshot low-power servers will provide counterweights to revenue pressure elsewhere in the business. The combination of lower revenue loss and more restructuring savings should allow HP to maintain or grow EPS next year.

Longer term, HP should be able to return to revenue growth after shifting more of its business to up-and-coming technologies. While many of HP’s product lines are declining, the company does have newer products like its “converged storage” solutions that are growing rapidly. Over time, the growth in these newer businesses will be better able to offset declining revenue and earnings elsewhere in the company.

Waiting for a signal
At its current price, Hewlett-Packard Company (NYSE:HPQ) appears to be significantly undervalued despite the challenges it faces. With the company trading for just 5.5 times free cash flow, there is a good margin of safety for value investors willing to wait for earnings improvement a few years down the road. However, investors who are more risk averse may want to wait until after the company’s annual analyst meeting in early October. At that time, we will get a better sense of the near-term outlook and the timeline for the rest of HP’s turnaround process.

The article HP’s Strange Fall: What Should You Do? originally appeared on Fool.com and is written by Adam Levine-Weinberg.

Fool contributor Adam Levine-Weinberg owns shares of Hewlett-Packard. The Motley Fool has no position in any of the stocks mentioned.

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