Robert Walberg

Street Patrol8/17/2006 12:21 PM ET

What happened to the PC market funk?

By Robert Walberg

Thanks to Dell (DELL, news, msgs) and International Business Machines (IBM, news, msgs), many investors and analysts assume that the PC market is in an industrywide funk. So how can you explain yesterday’s strong numbers from Hewlett-Packard (HPQ, news, msgs)?

H-P delivered its fifth consecutive quarter of better-than-expected earnings after yesterday’s close, the latest dividend of CEO Mark Hurd’s decision to take a hard line on costs when he assumed command of the company back in March of 2005. The computer and printer maker posted a gain of 52 cents a share on revenues of $21.9 billion. Wall Street had forecast 47 cents on sales of $21.8 billion.

Sales at H-P’s PC unit rose 8%, thanks to strong notebook sales. Meanwhile the unit’s profitability surged 69%, as operating margins improved to 4% -- the highest level since the merger with Compaq nearly four years ago. Management also noted that it sees PC demand remaining “roughly steady,” though it will keep a close eye on U.S. consumer demand. In other words, from where H-P stands, the PC market remains an opportunity for growth.

Dell gets it wrong

Contrast that with H-P’s chief competitor. After a long string of profit warnings, Dell reported today that its profit fell to $502 million, or 22 cents a share. The profit met Wall Street's lowered expectations but sales rose just 5%, the slowest rate in more than four years. (IBM got out of the business entirely, selling its PC unit to China's Lenovo.)

Dell has resorted to a scorched earnings policy of lower prices in order to maintain, or win back, market share. H-P has improved its margins and profits through a strict program of lower costs and strategic component purchasing. It is also taking advantage of Dell’s service problems, which grew more pronounced this week when Dell was forced to recall over 4 million batteries used in its notebook computers.

Put quite simply, H-P’s numbers suggest that while the PC market remains highly competitive, there’s still room for modest-to-strong growth for well-managed companies. Apple Computer’s (AAPL, news, msgs) recent success also lends support to this notion. The PC market as a whole isn’t in trouble -- Dell is.

H-P is enjoying the fruits of a cost-cutting plan that has already reduced headcount by nearly 10,000 employees, with another 5,000 slated to go over the next several quarters. Meanwhile Dell has been forced to bolster expenses to address its customer service problems. Costs related to increased staffing, additional call centers and aggressive marketing, combined with its campaign to lower prices, have hammered its margins and profits.

Bold steps pay off

By contrast, H-P announced that gross margins in all of its units rose last quarter and operating margins improved in all but one group. It expects the growth to continue, forecasting earnings of 61 to 63 cents a share on sales of $24.1 billion, slightly better than Wall Street estimates. To top it all off, the company announced a $6 billion share repurchase program.

With results like these it’s no wonder H-P’s shares set a new 52-week high in today’s session. The stock is currently up 4.6% on the day and 26% on the year. Considering the strong results last quarter, the positive guidance, a slew of positive comments from Wall Street and the company’s commitment to buy back its own shares, H-P’s stock is likely to continue climbing through year-end.

Meanwhile investors can’t seem to dump Dell’s shares fast enough. The stock is down 23% year-to-date and 38% over the past 52-weeks. At this point, you can’t even make a compelling valuation argument to buy Dell over H-P. Despite the obvious difference in performance since the start of the year, Dell still trades at a higher multiple to next year’s earnings than H-P does (17.8-times versus 15.4-times).

H-P may eventually run into trouble as the benefits from its restructuring effort run their course. Yet management seems aware of this possibility and is taking steps to bolster investment in faster growth areas (see the recent acquisition of software maker Mercury Interactive). Compared to the mess that is Dell, I’ll take H-P’s “problems” any day.

Robert Walberg is a financial writer based in Chicago, Ill. He was formerly chief equity analyst at Briefing.com. He is a regular guest on CNN's Moneyline. Mr. Walberg ran for Congress in Illinois in 1994.

At the time of publication, Robert Walberg did not own or control shares of any companies mentioned in this article.

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