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Hewlett-Packard: More to Come?

There is reason to believe this computer maker's renewed success is not just a flash in the pan.



Hewlett-Packard has hit its stride. A turnaround engineered by CEO Mark Hurd has dramatically cut costs and generated profit margins the technology giant has not seen since 2000. Sales of notebook and personal computers have contributed mightily to the company's performance. It's quite a reversal from the recent past when rival Dell ate HP's lunch in the PC business.

Investors have enjoyed the change in fortunes. Since Hurd joined the then-embattled company in March 2005, HP's share price has more than doubled. The good news keeps coming. On May 16, the company announced that sales rose 13% in the quarter ended April 30 and that profits jumped 28%. The results beat analysts' estimates, and HP again raised its revenue and earnings forecasts for the fiscal year.

The question for investors now is whether the stock can continue its run. Some analysts say the company's success is already reflected in its share price. "While HP has an impressive string of beat/raise quarters and fundamentals continue to improve, we believe much of the optimism has been factored in," says Brent Bracelin, an analyst at Pacific Crest Securities. He rates the stock (symbol HPQ) "market perform" -- that is, he's neutral.

Competition in the PC business is fierce and HP's progress could erode. On May 24, Dell (DELL announced a deal to sell its computers in about 3,500 Wal-Mart and Sam's Club stores throughout North America. This marks the first time Dell has ventured into selling its computers through retail stores. Historically, the company has sold PCs and other products directly to consumers and businesses over the phone and Internet, while HP has focused on selling through retailers.

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But there's reason to believe HP's renewed success with PCs is not a flash in the pan. Friedman Billings Ramsey analyst Clay Sumner thinks the strength of the PC business will keep surprising Wall Street. The company has revamped the way it distributes PCs to retailers, dramatically reducing inventory costs. "This change is not yet widely appreciated by investors, and as such, we expect HP to continue to outperform the market's expectations for its PC business," Sumner says.

Relentless cost-cutting has honed HP's competitive edge, and it's not over. The company plans to reduce its workforce by 15,300 employees. That and other measures will slash annual costs by $2 billion. HP will freeze the company's pension plan in 2008, further decreasing future benefit expenses.

And it plans to trim the number of data centers it operates and sell off excess real estate, which could lead to up $2 billion in additional costs savings, says Value Line analyst George Niemond. A leaner company means HP can cut prices on its products to increase sales and still maintain a high level of profits. "Assuming good execution, HP should still have several years of earnings growth that goes well beyond the growth of its revenue," says Goldman Sachs analyst Laura Conigliaro.

HP's shares have been fairly steady since the company issued its latest earnings report. Sumner sees no short-term event that would cause the stock to appreciate quickly, but rather expects the company to consistently beat Wall Street expectations over the next several years. The stock closed at $45.62 on May 25, up 0.48%. It trades at 16 times the average of analysts' earnings estimates of $2.78 per share for the fiscal year ending this October. Sumner and Conigliaro both rate the stock a buy and both have a target price of $53.



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