Hewlett-Packard: Ahead of the Pack

It's a tough time for tech giants. IBM missed its revenue targets. Wall Street worries about Dell's earnings outlook despite a 52% rise in fourth-quarter profit. Then, there's Hewlett-Packard (symbol HPQ). The company handily beat analyst expectations thanks to steady growth in its printer and PC businesses. It also forecast robust earnings for the rest of the year.

With the company less than halfway through its planned cost-cutting measures, more positive earnings surprises may be coming, says Prudential Equity Group analyst Steven Fortuna. "Cost savings, to date, represent only 40% of expected savings for the year, leaving considerable cushion to [profit] margins over the course of the next two to three quarters," Fortuna says. "CEO Mark Hurd continues to realize cost savings well ahead of plan."

Hurd came over from NCR last March, succeeding Carly Fiorina, whose widely panned acquisition of PC maker Compaq was seen as a drag on HP's profitable printer business. Competition by PC makers has been cutthroat as rivals such as Dell slashed prices to gain market share. As part of his plan to improve profitability, Hurd said last July that HP would lay off more than 15,000 workers and cut its stand-alone sales group. The company expects the move to save it $1.9 billion a year.

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What impresses Fortuna is the company's ability to squeeze out profits from the PC unit, which generated net profit margins of 3.9% in the past quarter, instead of solely going after market share. "While we still believe there is a fundamental margin disadvantage relative to Dell, HP is clearly closing the gap," he says.

Meanwhile, HP's printer business continues to flourish. Profit margins of 14.9% mean the company has room to focus more on research and development to stay ahead of competitors, says Fortuna. "At this point we do not see Dell as a risk to HP's printer franchise," he says. HP stock, currently $34 and near its 52-week high, sells at 18 times the $1.94 per share that analysts, on average, expect HP to earn in the year ending this October, according to Thomson First Call. Fortuna rates the stock "overweight" and has a 12-month price target of $39.

--Thomas M. Anderson