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Hewlett-Packard Co. (NYSE: HPQ) stock edged lower in after-hours trading after the company reported earnings that beat expectations but contained troubling signs that its five-year turnaround strategy is struggling.
Hewlett-Packard earned $0.90 a share in its fiscal first quarter, which ended Jan. 31. That easily beat expectations of an EPS of $0.84 a share and was an increase of 10% over the year-ago quarter.
Revenue was $28.2 billion, beating the expected number of $27.19 billion but still 1% lower than the year-ago quarter.
That's seems like good news, until you look at where the earnings came from. H-P's traditional businesses performed better than expected, while the units targeted for future growth slumped.
Sales of PCs, a source of recent weakness, were up 4%. And part of the beat resulted from lower expenses, one part of Hewlett-Packard's turnaround strategy that has been working well.
Prior to this quarter, restructuring and aggressive cost-cutting had produced savings of about $1.00 per share. That, in turn, underpinned an improvement in fundamentals that has pushed Hewlett-Packard stock up 75% over the past 12 months.
But as a report card on how the rest of H-P's turnaround strategy is faring, these earnings get poor-to-middling grades.
The enterprise group, which includes H-P's server business, did manage a 1% revenue increase with stable margins. That helped results, as the segment accounts for about 45% of Hewlett-Packard's profits.
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The news after that is all downhill. Printing revenue was down 2%; margins edged downward from 17.7% to 16.8% from the previous quarter.
Enterprise services revenue was down a disturbing 7%, and margins plunged to 1%. This is particularly troubling for a unit that is supposed to be one of Hewlett-Packard's new engines of growth.
And revenue from software, the other hoped-for source of future growth, slumped 4% year over year with margins sliced in half from the previous quarter, to 15.8% from 30.8%.
It looks like H-P's comeback might take longer than anyone anticipated.
"They are like a country, and it's tough to get all of the elements of this country moving enough to move the needle (in terms of growth)," Richard Kugele, an analyst for Needham & Co, told IBD.
Hewlett-Packard Co. (NYSE: HPQ) Stock Needs Turnaround to Succeed
Confidence in the cost-cutting and long-term turnaround strategy had bled into 2014, with Hewlett-Packard stock up nearly 8% year to date despite a rocky January for the markets.
That ride may take a pause given this latest earnings news.
The kind of makeover H-P is attempting is not easy, particularly for a company of its size.
"There is a lot of really tough stuff, things that are not quick fixes like wrapping up a number of unprofitable services deals and signing more deals in places like applications services and technology services," Crawford Del Prete, an analyst for research firm IDC, told Investor's Business Daily. "I do think they are getting closer."
The basic idea behind the H-P turnaround plan is to slowly move away from its reliance on PC sales in favor of business areas that are growing – the cloud, cybersecurity, 3D printing, and Big Data.
That means a greater shift toward software and services as well as a reassessment of its large server business, which is under pressure from rivals willing to cut prices.
It's vital that Hewlett-Packard find new sources of growth, but it's just as important that the company move away from businesses with low or shrinking profit margins for ones with fatter margins.
That's why the company's Q1 earnings are somewhat disappointing. So far, H-P just hasn't gotten much traction in those new growth areas.
Hewlett-Packard stock closed at $30.19 on Thursday, up 2.51%.
The main threat to H-P's server business comes from a company that has made its name by becoming a dominant force in the PC business, despite the challenges. This company is now poised for really big things. In fact, it just might be the new king of the computer industry…
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