HP's Earnings Beat: Wall Street Concerns Linger

NEW YORK (TheStreet) -- HP (HPQ) blew past Wall Street's estimates in its first-quarter results released on Thursday and raised the low end of its full-year guidance, much to the relief of investors. Wall Street analysts, however, still have concerns about the tech giant's long-term prospects.

Nonetheless, HP delivered some good news for its long-suffering investors. The company's shares were up 0.86% to $30.45 in premarket trading, lifted by a healthier PC market and improved full-year guidance.

HP's Personal Systems revenue increased 4% year over year to $8.53 billion, with CEO Meg Whitman highlighting an improvement in the PC market.

"What most people will be surprised about on this earnings call will be how well PSG did," she said during a conference call on Thursday. Whitman pointed, in particular, to a "tailwind" in users' migration from XP to the latest versions of Windows, and a "long overdue" PC refresh. Employees, according to the HP chief, are asking not only for the latest tablets, but also new PCs.

Recent quarterly numbers from chip giant Intel (INTC), a key tech bellwether, also indicated that the PC market may be bottoming out.

Whitman, however, was unwilling to predict whether the positive trend will continue throughout the year. "It's hard to call it, this has been, over the last few years, a pretty volatile market," she said, in response to an analyst's question. "I think's it's too early to call."

Investors also received an update on Whitman's efforts to breathe new life into HP. The CEO is 26 months into a major five-year plan to revitalize the once-embattled PC maker. Speaking during the earnings conference call, she said that the company's turnaround is becoming a competitive advantage.

"Two-and-a-half years ago, we embarked on some pretty significant changes to this company around the cost structure, around our pivot to the new style of IT, around investments in innovation," she said. "We totally understood what was happening in this market two years ago and we began to take actions, and I think what you see is our competitors now having to take some of the same actions around cost reduction."

One of HP's major competitors is IBM (IBM), which recently announced the sale of its low-end x86 server business to Lenovo. "It does create an opportunity for us," said Whitman, in response to an analyst's question. "I think that we have a near-term opportunity here to gain share in our server business -- we're all over it, we're all over it with our server partners."

Plenty of attention was focused on HP's free cash flow, a key metric for dividend payments and share repurchases. This number was $2.4 billion during the first quarter, down from $3 billion in the same period last year, but up from $2.1 billion in the prior quarter.

Speaking during the earnings conference call, HP Chief Financial Officer Cathie Lesjak noted that operating cash flow was $3 billion, up 17% on the prior year's quarter. HP also got its cash conversion cycle down to 16 days from 23 days in the fourth quarter, she added.

HP's non-GAAP operating margin was 8.5%, up from 7.9% in the year-ago quarter, but down sequentially from 9% in the fourth quarter.

For the second quarter, HP expects earnings of between 85 cents and 89 cents a share, at the low end of Wall Street's estimate of 89 cents. For fiscal 2014, the Palo Alto, Calif.-based firm predicted earnings of between $3.60 and $3.75 a share, higher at the low end than its previous guidance of $3.55 to $3.75. Analysts were looking for fiscal-year earnings of $3.67 a share.

Despite the first-quarter beat, however, there are lingering concerns on Wall Street about HP's long-term growth and the competitive landscape. Here's what analysts had to say:

UBS analyst Steven Milunovich (Neutral, Price Target raised to $32.50 from $28.50) 

"We credit management with better execution that resulted in PC and x86 server increases and the third consecutive quarter of rising printer placements, which should help supplies later in the year. Meg Whitman pointed out that 'At a time when many of our competitors are confronting new challenges, two years of turnaround work is setting us up for an exciting future.' While the product set has been bolstered, mostly she is referring to a head start on cost cutting, which might benefit HP by about $0.50 this year. Perhaps the biggest positive is the bump up in FCF expectations from $6.0-6.5bn to our estimated $7.3bn due to a better cash conversion cycle.

"Remain concerned about revenue exposures....Most important is the revenue mix-HP gets only 5% of profits from software and is dependent on printers and Technology Services, questionable long-term businesses, for about 60% of profit." 

Cantor Fitzgerald analyst Brian White (Hold, $27) 

"Last night, HP reported 1Q:FY14 results with sales upside from better-than-expected PC performance and one-time gains benefiting EPS; however, the company's 2Q:FY14 EPS outlook is a bit muted. Calendar year 2013 was the third consecutive year of declining sales (down 6%) and EPS (down 8%) for the company. Despite a difficult year on a fundamental basis, the stock increased 96% in CY:13 and has risen another 8% thus far in 2014. Looking forward, we believe investors will increasingly require convincing proof that HP's turnaround has long-term, fundamental underpinnings that have the potential to re-position the company for the next wave of IT spending growth; however, we did not hear evidence of this on last night's call."

Jefferies analyst Peter Misek (Hold, $30) 

"HP beat on EPS due to large IP and real estate sales and beat on revs mainly due to strong commercial notebooks, which we believe is driven mostly by XP endof-lifing in Apr. FQ2 guidance was light but the low-end of FY14 guidance was raised, implying a further H2-loaded year. We continue to be impressed with HP's execution and we see an H2 enterprise IT hardware rebound, but we also think secular headwinds will make a return to rev growth difficult." 

J.P. Morgan analyst Mark Moskowitz (Overweight) 

"Rolling Along: Revenue Beat Stands to Increase the Potential of a Crossover to Positive YoY Growth. We expect shares of Overweight-rated Hewlett-Packard to be upward trending in the near term. The company delivered a big Jan-Q revenue beat, which could attract more long-term investors to the story. HP also beat on EPS and cash flow, although one-time events helped. Set against a mixed economic environment, HP's results and sturdy outlook were positive outliers as the first earnings season of the year wraps up." 

ISI Group analyst Brian Marshall (Neutral) 

"Transformation continues, but hard to re-build asset base. HPQ's stock has more than doubled from the start of 2013 (vs. the S&P 500 up ~30%), but it would be a mistake in our view to think HPQ's recovery is now on solid footing. While management may trade off between revenue and gross margins from quarter to quarter (i.e., "giving" business away to stay in key accounts, etc.) we believe gross profits are the best indicator of technology relevance. By this measure, the picture remains bleak (e.g., down almost 20% in 3 years) as many customers migrate to alternate or commodity solutions. Cash flow and EPS have been preserved by favorable working capital adjustments and OpEx cuts (e.g., ~$1.5bil annualized reduction from peak levels)." 

"While we anticipate HPQ will continue finding avenues for expense reduction (much like IBM), it doesn't provide the receipe for restoring growth/competitiveness. We applaud management creating a much strong organization through "nuts and bolts" improvements but secular and competitive pressures remain as intense as ever and we do not believe HPQ's technology asset base is evolving fast enough to keep up." 

-- Written by James Rogers in New York.

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