HP: Merrill Throws in the Towel, Services The Main Issue
Merrill Lynch's Scott Craig today cut his rating from Buy to Neutral on shares of Hewlett-Packard ( HPQ ) following HP’s first analyst day event addressed by chief executive Meg Whitman , yesterday, which included a diminished outlook for for profit next fiscal year starting in November. Craig cut his price target to $16.50 from a prior $22. Yesterday's presentation has prompted numerous cuts in estimates and price targets today, though Craig's appears to be the only actual downgrade of the stock. The stock's valuation is still attractive, however, "We have clearly underestimated the scope of and time required for HP’s turnaround," writes Craig. "While we found greater details provided by management on HP’s turnaround strategy and long-term growth expectation to be helpful, execution, timing, and company fundamentals are clearly more challenged than we originally assumed." The whole problem for HP, leaving aside a weak PC market and printer troubles and all the rest, is really the complex deterioration of its services business, writes Craig, and he doesn't seem to see things getting better any time soon: We believe there are further bumps in the road for Enterprise Services, and HP management expects revenue in this segment to decline 11 to 13% in F2013 due to four major accounts reducing their services spend with HP (accounts for 5% of decline), walking away from low margin deals (3% decline), lower new revenue from low book to bill in F2012 (1-3% of decline) and currency (2% decline) [...] Over the long-term, HP’s management expects revenue growth of 3-5% and operating margin of 7-9%. We model Services revenue of $31 billion in F2013 (-12% Y/Y) and operating margin of 8.9% (-210bps), with ES (ITO & ABS) revenue declining 13% Y/Y and op. margin further contracting to 0%.