When your most profitable business operates in an industry seeing a long-term decline, good execution might only get you so far.
The financial outlook and restructuring plan shared by HP Inc. (HPQ) at its Thursday analyst meeting -- and the market's reaction to it -- drives this home. The PC and printing giant's stock has dropped about 10%, and made new 52-week lows, after it:
- Announced it's cutting 7,000 to 9,000 jobs, or about 13% to 16% of its workforce.
- Disclosed it has added $5 billion to its stock buyback authorization, and plans to hike its dividend (current yield of 3.8%) by 10%.
- Guided for fiscal 2020 (ends in Oct. 2020) non-GAAP EPS of $2.22 to $2.32 and free cash flow (FCF) of "at least" $3 billion, versus consensus estimates for EPS of $2.24 and FCF of $3.72 billion. Excluding expected restructuring costs, FCF guidance would be "up to" $400 million higher.
- Said it plans to spend at least 75% of its fiscal 2020 FCF on buybacks and dividends.
Notably, HP didn't provide any formal revenue guidance. However, CFO Steve Fieler did state that HP expects its printing supplies revenue, which accounts for much of its gross profit, to drop in fiscal 2020. He also suggested HP's top line will more broadly be pressured by macro headwinds and "competitive" market conditions, and noted currency headwinds are expected to impact revenue growth by about 1%.
Currently, the consensus is for HP's total revenue to drop 1% in fiscal 2020 to $58.3 billion, and for its printing supplies revenue to drop 5% to $12.9 billion.
While large job cuts and buybacks could prop up HP's EPS over the next few quarters, the secular headwinds faced by its Printing segment, whose operating profit remains more than 70% greater than that of its Personal Systems (PC) segment, could make long-term growth harder to come by. If one wants to better understand why, slide 6 in the presentation shared by HP Imaging & Printing chief Tuan Tran would be a good place to start.
HP's expectations for its addressable printing markets. Source: HP.
In that slide, HP highlights its growth opportunities in an industrial graphics printing total addressable market (TAM) estimated to currently be worth about $50 billion. However, the company forecasts its home printing TAM, estimated to be worth about $35 billion, will decline at a 4.5% compound annual rate from 2019 to 2023. And it forecasts just 0.4% compound annual growth for its office and media printing TAMs, which are respectively pegged at about $100 billion and $20 billion.
It's hardly a given that HP's office and media printing TAMs will register even those modest growth rates. With each passing year, consumers and businesses alike are relying more and more on PCs and mobile devices to view and share content that may have once been printed out -- family photos, Word documents, PDFs, PowerPoint slides and newspaper and magazine articles all fit the bill here.
To some degree, HP's investments in offerings such as managed printing services for businesses and its Instant Ink ink-replacement plans could help offset these secular growth headwinds. But on the flip side, as HP has noted, its printing business is also facing other growth pressures, such as stiff competition from third-party supplies providers for HP printers and the growth of online sales channels in which HP has a relatively low market share.
This mixture of secular and competitive headwinds goes a long ways towards explaining a strategic change that HP unveiled at its investor meeting. Going forward, the company will charge more for printers that are capable of using third-party ink, while offering subsidized prices for printers that can only use HP ink.
Historically, HP has been comfortable with a Gillette-like business model in which it often sells printers at a loss and subsequently makes it up via high-margin ink sales. But with consumers and businesses now (on average) needing less ink, and with some of them now more likely to use a third-party supplier when it is time to upgrade, HP apparently concluded that it needed to change up its hardware pricing...even if it could lead to some share loss.
In many ways, HP's management deserves credit for making the best out of a difficult situation in recent years. Financial discipline and buybacks have helped EPS grown in recent years amid top-line headwinds; the company has upped its exposure to growing parts of the printing industry such as managed services and industrial graphics; and it has expanded its addressable market by entering the 3D printing and A3 copier markets.
One could also add that HP's PC business has moderately grown its top line in recent years in the face of a flat-to-declining market, thanks to share gains made possible by good operational execution and the launch of more compelling consumer and business notebooks. Research firm IDC estimates HP had a 23.2% PC shipment share in 2018, which is up from an 18.4% share four years earlier.
However, if the printing supplies market is going to remain both competitive and in a secular decline, then delivering meaningful, long-term, HP is still likely to have a tough time delivering meaningful, long-term earnings and cash-flow growth. And markets will price its stock accordingly.