H-P Humming Along

The push for improved profit margins continues to pay off.
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In a quarter that has wounded so many tech giants,


(HPQ) - Get Report

bottom-line beat on Tuesday had its investors feeling giddy amid another down session in tech stocks.

Thanks to strong profit margins across many of itskey businesses, H-P boosted its net income by morethan 50% year over year, with an EPS several cents aboveWall Street estimates -- the latest in a string ofimpressive results produced by the company'srestructuring plan.

"HP is a company that we think is really in asweet spot right now," said Mark Hillman, the chief information officer ofHillman Capital Management, which has a long positionin the company. "We think

CEO Mark Hurd is justgetting started as far as making the enterprise moreefficient and more profitable."

The company achieved 24.8% gross margins and 8%operating margins during its fiscal second quarter,its highest level in years, according to analysts.

And the prospect that even more savings lie aheadwas enough to put aside, at least for the moment, anyquestions about the company's top line, which grew 5%year over year to $22.6 billion during the quarter.

Shares of H-P were recently up 3.7%, or $1.14, at $32.25 onWednesday morning.

By contrast, shares of


(INTC) - Get Report



(DELL) - Get Report



(MSFT) - Get Report

are all down or flatthis earnings season.

A tech landscape clouded by slowing PC demand andrumors of price wars has contributed to the Street'sglum outlook. (Indeed, the


was falling another 1% on Wednesday.) But investors appeared confident thatthe course set by H-P's management would protect thecompany from any unpleasantness.

"In the current environment, HPQ could be one ofthe best defensive stocks, providing both a shelter inthe midst of a battered tech tape and a solidopportunity for upside," wrote Goldman Sachs analystLaura Conigliaro in a note to investors raising herearnings estimates for H-P. (Goldman Sachs has receivedcompensation from H-P for investment banking andnoninvestment banking services in the past 12 monthsand is a specialist in H-P securities).

To view Street Insight's video review of Hewlett-Packard, please click here


Conigliaro said the company's core strengths inthe consumer market, emerging markets in EasternEurope and its channel distribution model are allassets that rival Dell does not possess. These, shesaid, should insulate H-P from the effects of theprice cuts that Dell announced last week.

Another asset helping H-P in the current techenvironment is the progress it has made realigningits cost structure.

H-P's printer business notched 15.5% operatingmargins in the fiscal second quarter. Not only wasthis up from the 12.7% level of a year ago, it wasabove the 13% to 15% range that H-P has set for itsprinter group to achieve next year.

The server-and-storage group also reported strongprofitability, boosting operating margins to 7.5% from4.3% a year ago, as did the PC business, whose 3.6%margin was up from last year's 2.3%.

Hurd stuck by the company's margin targets for2007, despite the fact that many of the businesses arealready within or above the desired range. Butinvestors and analysts seemed convinced thatmanagement is being conservative and that H-P hadfurther room for margin improvement.

"The company is only just over halfway done withits planned job cuts, which means it is beating marginforecasts without as much help from restructuring,"wrote UBS analyst Benjamin Reitzes in a note toinvestors Wednesday.

Thus, said Reitzes, H-P has even morerestructuring savings slated to hit the bottom line inthe coming quarters. And H-P will be able to use theseforthcoming restructuring benefits later on to offsetpricing pressure from companies like Dell. (UBS makesa market in HP securities and has provided H-P withinvestment banking services within the past threeyears and noninvestment banking services within thepast 12 months).

As if on cue, H-P announced early Wednesday thatit is consolidating its 85 worldwide data centers intosix U.S. locations, a move that it expects will save$1 billion in IT costs over the coming years.

Revenue in H-P's PC group rose 10% year over yearin the second quarter, thanks to strong double-digitsales growth in notebooks and consumer PCs. Hurd saidthat H-P had gained 1.4% of PC market share worldwideand 2% in the U.S. during the quarter.

"The market growth continues to be led by a shiftto mobility, strength in emerging markets andconsumer," Hurd told analysts in a conference callfollowing the earnings release Tuesday.

Printer supplies were another big revenue enginein the fiscal second quarter, increasing 10% year overyear, following on the first quarter's impressive 11%growth.

Less stellar was the 3% growth in printer hardwareunits during the second quarter. And the servers-and-storage division managed to log only a 2% revenuegrowth in the quarter, despite the fact that H-P's useof

Advanced Micro Devices

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Opteron processors provides it with a big advantageover Dell, whose servers use Intel chips exclusively.

Hurd said he was not satisfied with thisperformance and that H-P was beefing up its salesforce to accelerate revenue growth.

What level of overall sales growth the company isultimately capable of generating is still an openquestion.

Eventually, "HP's ability to continue to increaseits margins could become increasingly challenging,"wrote Needham and Co. analyst Charlie Wolf in a noteto investors. "When that occurs, possibly by 2007,mid-single digit revenue growth will not be sufficientto propel the stock higher." Needham does not haveany business relationships with H-P.

According to Wolf, who rates H-P hold, a7.5% revenue-growth rate (which is above the 4% to 6%growth rate that H-P has set for 2007) and 8.5%operating margin produces a fair price of $26 forH-P's stock.

But with profit climbing 50% as it did lastquarter, most investors have plenty of good news tofocus on.