investors snapped up shares Wednesday in the wake of a third-quarter
financial report that won praise on Wall Street.
Shares rose 10% to $26.05 Wednesday, lifting the stock within a dime of a four-year high and making it the second-best-performing stock in the
Dow Jones Industrial Average
The major gains in the stock have been booked since Mark Hurd came aboard as chief executive in late March. Investors have plowed into the stock on the expectation that he is right person to turn this technology giant around.
He has focused so far on streamlining H-P and cutting costs, instituting two restructurings, one involving a realignment of business units and another involving a 10%
workforce reduction. As for financial results, H-P beat its earnings and sales targets for the latest quarter and issued fourth-quarter earnings targets that were ahead of expectations.
Still, this is a company that faces a myriad of challenges, including a price war in its most profitable business segment and stiff competition for sales of IT hardware from the high end in
and from the low end in
. Hurd has yet to reveal a long-term plan for H-P, but the competitive pressures working on H-P are significant.
The impact of these issues can be seen in the company's profitability.
Even though H-P eclipsed the Street's earnings targets, 3 cents a share of the upside for the previous and current quarters stemmed from extra interest income. That's pretty simple to obtain for a company with $14.4 billion in cash and a debt load of $5.8 billion in a period of rising interest rates.
As for the company's overall gross margins, they shrank to 23.2% from 23.8% in the previous quarter. Operating profit margin of its printing and imaging unit, its most profitable business, expanded sequentially to 13% from 12.7% but shrank from 14.9% in the same quarter last year.
In its personal systems group, which posted strong growth and profitability increases in the quarter and accounted for most of the unexpected upside in the period, operating profit remained meager at 2.6% of revenue vs. 2.3% in the second quarter and 0.4% in the same quarter last year.
Likewise, operating margin in its enterprise storage and server business also improved but remained below 4%.
Coming cost cuts will lower the company's cost base further, but the stock's rally in the past three months has anticipated this improvement. Investors are now nearing a point when the value in the shares must be weighed against how far this business can go.
Analyst Robert Cihra with Fulcrum Global Partners said that even with the restructurings, competitive pressures in "multiple areas" are likely to keep H-P's gross margins flat from this year to next. He is neutral on the stock and had no disclosures related to the company.
He was in the minority on Wednesday as other analysts lauded the company, its new leader and its prospects.
Analyst Andrew Neff with Bear Stearns upgraded H-P's stock Wednesday to outperform and slapped a $35 price target on the shares as he sees continued earnings upside in the year ahead. He said H-P shares should be valued toward the high end of its historic averages because of its current momentum.
"To a large extent, our upgrade reflects a history of turnarounds and CEO Hurd's legacy at NCR, where he had a history of soundly beating financial targets," Neff wrote Wednesday. "While it's not clear if H-P can be a compelling growth story, it's taking required steps to unlock further EPS leverage." Bear Stearns seeks business with the firms it researches.
Investors voted loud and clear Wednesday with their wallets on where they see the company going. Shares rallied through morning trading and held gains into the afternoon. Hurd so far has offered good reasons for optimism, but he's not immune to the intense competition and tight margins that characterize the IT hardware arena. Investors aren't immune either.