3 Reasons Why HP Is Positioned For A Comeback

Hewlett-Packard (HPQ) will likely end 2012 with its stock performing worse than it has in the last 5 years. At a recent price of $14.12, HP so far returned a 43.6% loss to shareholders in 2012. The company ends the year with massive write-downs, and enterprise revenue growth unable to offset margin declines in printers and personal computers. Despite management guiding the timing of its turnaround over multiple years, investors still hoped Microsoft's (MSFT) Windows 8 would accelerate HP's revival. It will become clear that Windows 8 will not strengthen PC sales in the short-term. With HP shares trading at a forward P/E of just 4, investors are right to wonder if the company is even positioned to make a come-back.
Now that the majority of cost reductions are complete, discipline is assured for future acquisitions, and operational efficiencies in focus by the company, HP's comeback is possible.
There are 3 reasons why.

1) Depreciation, Depletion, and Amortization are Complete
HP wrote-off a large portion of over-paid acquisitions that did not add value to the company. For fiscal 2012, the deduction was nearly 4-times higher than in previous years. By reducing the book value of Autonomy by $8.8 billion, the company may begin fiscal 2013 with a cleaner balance sheet:

	10/31/2009	10/31/2010	10/31/2011	10/31/2012
Depreciation, Depletion and Amortization	4,773	4,820	5,869	23,130

Data Source: Kapitall.com

2) Positive Cash Flow for the Fiscal Year
HP will end the fiscal year with positive cash flow. The operational cost reductions taken during fiscal 2012, along with staff reductions, should give management room to enhance its core computing businesses. HP will need to stop selling computers at near-zero margins. This may be accomplished in two ways. First, efficiencies in the way advertising is done for its hardware must be improved. HP had an advertising budget of over $1 billion (from its last form 10K). Second, R&D expenses needs to result in the development of mobile computers that compete more effectively against Lenovo and Asus.

	10/31/2009	10/31/2010	10/31/2011	10/31/2012
Cash Equivalents Beginning of Period	10,153	13,279	10,929	8,043
Cash Equivalents End of Period	13,279	10,929	8,043	11,301

Data Source: Kapitall.com

3) Higher Margins Are Possible
Although it is well-known that HP makes very little profit in sales of personal computers division, the company as a whole consistently produced gross profits of between 23% and 24% of total sales in the last four fiscal years:

	10/31/2009	10/31/2010	10/31/2011	10/31/2012
Net Sales or Revenues	114,552.00	126,033.00	127,245.00	120,357.00
Cost of Goods Sold	87,524.00	96,089.00	97,529.00	92,385.00
Gross Profit	27,028.00	29,944.00	29,716.00	27,972.00
Gross Profit / Net Sales	24%	24%	23%	23%

Data Source: Kapitall.com
Improving gross profits will only be possible if HP increases its focus on enterprise sales. Enterprise growth trends are favorable. Cloud computing growth will keep growing, thanks to higher demand for cloud data consumption. The management and demands for analyzing Big Data will also grow in 2013, regardless of the state of the macro economy. These trends would support enterprise hardware and software sales for HP.

Risks
First, HP still has a sizable debt load. The company only managed to reduce its debt last year by a small amount:

	10/31/2010	10/31/2011	10/31/2012
Long Term Debt	15,258.00	22,551.00	21,789.00

Second, mobile computing, notably in the tablet and smartphone space, will outpace the growth in personal computer devices. HP could offset its lack of presence in these areas in two ways. In the emerging markets, PC demand could grow to offset revenue declines in developed regions. The company could also grow sales in the enterprise space, despite heavy competition from Salesforce.com (CRM), Oracle (ORCL), and IBM (IBM).

Conclusion
HP is not a quick turnaround story. After massive write-downs in 2012, HP has an improving balance sheet that suggests the risks are vastly reduced for shareholders. HP's forward P/E is 4. By comparison, Microsoft has a forward P/E of 9, Oracle at 13, Red Hat (RHT) at 56, and Google (GOOG) at 20. This means that investors have low expectations for HP.
A rebound in HP's shares will only accelerate as enterprise sales grow as a percentage of total sales. Despite the Autonomy write-down mess, sales for Autonomy software could potentially grow in 2013. As the turnaround story in HP continues successfully into 2013, it is positioned to accelerate each year after that.