H-P Putting Growth Engines to Test

Investors will be gauging the effects of the tech giant's turnaround initiatives and PC gains.
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In December,


(HPQ) - Get Report

flagged three business trends as its main growth drivers going forward: mobility, printing and data centers.

When the company reports its second-quarter results after the bell Tuesday, investors will be looking for signs of just how much growth this trio can provide and whether H-P's shares, which are up 57% over the past 12 months, have more headroom.

Over the past several quarters, H-P has been in fix-it mode, cutting costs and retooling its business operations under a turnaround regimen imposed by CEO Mark Hurd.

With H-P having met many of its profit-margin goals during its last quarterly report, however, the stage could be set for a preview of the capability of the company's chosen growth drivers.

Analysts are looking for H-P to earn 49 cents a share on revenue of $22.6 billion in the second quarter, at the high end of the company's guidance of 47 cents to 49 cents EPS and $22.4 billion to $22.6 billion in sales.

If H-P meets expectations, its top line will be slightly down sequentially, in keeping with the seasonally slow start of the year, and up 4.6% year over year.

Of course, for a company the size of H-P, eking out even modest revenue growth is no small feat. H-P's target for fiscal 2007 calls for revenue growth between 4% and 6%.

Moors & Cabot analyst Cindy Shaw believes that H-P has recently shifted gears from cost-cutting mode to growth.

"We believe

Hurd is satisfied that cost-cutting is on track and has recently made revenue growth a top priority," wrote Shaw in a recent note to investors.

And H-P's plan of reinvesting restructuring savings into growth initiatives, along with its renewed focus on high-margin businesses, could accelerate the company's pace of revenue growth, wrote Shaw, who has a buy rating on H-P and whose firm does not have any banking relationship with the company.

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If H-P meets the average analyst revenue estimate of $90.9 billion for 2006, says Shaw, the company could overtake


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and become the world's largest tech company.

But all has not been well in the tech market of late. Demand for personal computers in 2006 is expected to be down from previous years,


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has delayed the release of its Vista operating system, and technology bellwethers


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have recently slashed their financial forecasts.

Last week, Dell revealed that it had made some

aggressive price cuts on PCs toward the end of the quarter. This discounting could sap H-P's PC sales and threaten recent profit-margin gains if H-P opts to respond with price cuts of its own.

In the previous quarter, H-P boosted its PC operating margins to 3.9%, the highest level in years and near the top of the company's goal of 3% to 4%.

Key to this profitability has been the role of notebook computers, which command higher prices than desktops and are selling at a much brisker pace.

According to industry research firm IDC, H-P's worldwide PC shipments were up 22% through March. But those figures don't account for Dell's price cuts, which appear to have commenced in April.

Tuesday's earnings report should provide important details about how H-P's notebook sales and average selling prices fared during the remainder of the quarter, as well as the company's expectations for notebooks in the months ahead as Dell's price cuts kick in.

Meanwhile, shipments of H-P's handheld products, which the company recently broke out into its own business unit, plummeted 30% year over year in the first quarter, according to IDC, in line with the 22% industrywide decline.

Printers are also somewhat of a question mark. In April, printing rival



reported first-quarter revenue that was down 6% year over year.

While Lexmark has been coping with many internal issues in recent quarters, some analysts wonder whether the poor results could indicate broader issues afoot.

"On one hand, issues at Lexmark could be a positive for H-P in terms of H-P gaining share, but we think that Lexmark's struggles probably also reflect some amount of softness in overall demand for printer hardware and supplies," wrote A.G. Edwards analyst David Wong in a recent note to investors. (A.G. Edwards has provided non-investment-banking services to H-P in the past 12 months.)

And after H-P's strong 11% growth in printer supplies during the first quarter, growth could level off in the second quarter, says Wong.

All this has added uncertainty to H-P's companywide growth potential, which is something the Street is still trying to gauge.

"People understand the benefits of the restructuring process -- that

partseems fairly clear," says Chirag Vasavada, a hardware analyst at T. Rowe Price. "The question is around how quickly and how fast can this company truly grow."

Vasavada doesn't believe that Dell's PC price cuts will have as significant of an impact on H-P's growth as many people assume, given the fractured nature of the PC market. There's room for both companies to grow, says Vasavada, whose firm has positions in H-P and Dell.

As H-P evolves beyond its status as a value stock, however, Vasavada says the company is at a transition point where it needs to sell investors on its growth potential.

The earnings report is likely to provide some early clues.

Shares of H-P were recently trading down 10 cents to $31.53.