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HP Earnings: Not So Strong at Second Glance

NEW YORK ( TheStreet) -- Last week's second quarter earnings from Hewlett-Packard (HPQ - Get Report) came in well above analyst expectations, sending the stock to new highs for the year (just south of $25).

But when we look deeper into the numbers, larger evidence of weakness becomes apparent. Quarterly sales dropped in 13 of HP's 15 business segments. Strong negatives were seen in laptop sales (the largest part of the company's PC division), which fell by 24%. The only positive areas were in sales of printing supplies (higher by 2%), and in networking equipment (higher by 1%). On a yearly basis, quarterly net income at HP dropped 32%, to $1 billion, or 55 cents per share. Revenue was 10% lower at $27.6 billion.

Cash flow, however, did see a substantial increase, rising 44%, to $3.6 billion. At 87 cents per share, HP's net income beat Wall Street's consensus estimate at about 81 cents per share on revenue of $28.1 billion. This upside surprise was enough to create a bullish response for the stock. But wider challenges in HP's core markets suggest these elevated levels create an opportunity to sell the stock, not buy it.

Challenges in the PC Market

Longer term, some clear challenges confront the PC market. Recent earnings disappointments at companies like Dell (DELL) show that the future of the PC market is questionable at best. For HP, these concerns extend into areas like services, servers and printers. So, while there were modest short-term improvements for HP, broader trends in many segments have already started to show significant weakness.

To meet these challenges, HP will need to modify its businesses and adapt to the changing demand of the consumer. But the reality is that successful examples of these types of brand reformation are rare. Apple (AAPL) is perhaps the best example of a company that faced a desperate situation (lack of competitive edge, stalling stock prices), and still managed to turn things around in a big way. But HP is a very different type of company, and attempts at innovation in music and mobile devices will not be viable.

Period of Transition

Meg Whitman assumed the role of CEO at HP nearly two years ago. The company is still the world's largest producer of IT hardware but its overall performance has been lackluster, as declining sales and new market competition add to its list of challenges. HP's balance sheet remains a point of weakness but this is not altogether surprising given that the company has changed its chief executive four times in the last six years.
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