Shares of HP Inc. (NYSE: HPQ), one of the biggest players in the PC and printer markets, look tantalizingly cheap. Warren Buffett’s Berkshire Hathaway owned more than 12% of the company as of June 30, with a stake worth about $3.5 billion. Based on the average analyst estimate, HP stock trades for about 9 times forward earnings.
There are some good reasons why HP stock trades at such a beaten-down valuation. For one, neither of its core businesses looks particularly appealing from a growth perspective. Prior to the pandemic, the PC market was stuck in a slow decline. While the pandemic reversed this trend temporarily, there’s little reason to believe PCs will be able to drive significant long-term growth for HP.
HP’s personal systems segment suffered an 11.3% year-over-year revenue decline in the fiscal third quarter, which ended on July 31. HP likely gained market share — global shipments during the calendar second quarter dropped 13.4%, according to IDC. HP shipped 3% more units than during the prior-year period, but average pricing tumbled by a double-digit percentage.
There’s still too much inventory across the PC industry, which is putting pressure on pricing. This was true for both consumer and commercial PCs. Another headwind is weak demand in China. HP expects the inventory situation to be largely normalized by the end of its fiscal fourth quarter, which could lead to an improving pricing environment.
The printing business, while highly profitable thanks to high-margin sales of printer supplies, is also in decline. Printing revenue sank 7% year over year in Q3, with hardware units down 19% and supplies revenue down 2%. Plunging hardware shipments today could lead to lower supplies revenue down the road .
HP has managed to cut costs and prop up its segment operating margins despite revenue declines, but the overall bottom line was down significantly. In the personal systems segment, HP reported a 6.6% operating margin thanks to lower commodity costs, structural cost savings, and the simplification of its product portfolio. In the printing segment, operating margin of 18.6% was down slightly due to an aggressive pricing environment and currency .
Adjusted earnings per share (EPS) came in at $0.86 in Q3, down 17% year over year. For the full year, the company expects adjusted EPS to sink about 19% to a range of $3.23 to $3.35. Free cash flow will fare even worse. The company now expects to generate full-year free cash flow of $3 billion, down 23% from last year.
As HP grapples with sinking demand and tough pricing environments, the company’s balance sheet has worsened significantly over the past year. HP’s net debt now stands at $8.1 billion, down from $5.8 billion one year ago. One reason for the deterioration: The company poured cash into share buybacks last year when its stock was trading near all-time highs.
While there are pockets of the PC and printing industries that have meaningful growth potential, including gaming PCs, industrial graphics, and 3D printing, HP operates in two markets that are tough to get excited about. Once the PC market bottoms out and normalizes following its post-pandemic slump, minimal annual growth is likely the best HP can hope for.
In the printing market, a long-term decline is likely in the cards. IDC expects global printer shipments to never exceed pre-pandemic levels again. HP can wring out plenty of profits, but printing is just not a growth business.
Because HP’s long-term growth potential is so lackluster, the stock could remain “cheap” indefinitely. While it may seem tempting to buy HP stock given its single-digit price-to-earnings ratio, it looks unlikely to provide market-beating returns in the long run.
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