HP aims to extend winning streak

NEW YORK (CNNMoney.com) -- A role model for corporate ethics, Hewlett-Packard is not. But the world's leading computer maker hasn't lost support from investors, who are focused on one thing: earnings.

HP became the poster child for corporate governance gone disastrously wrong this year when it admitted it spied on board members and journalists during the course of a leak investigation.

Despite a scandal that has rocked the legendary computer maker, HP shares have kept climbing.

Battle of the PC makers The world's No. 1 and No. 2 computer makers are both due to report earnings after the market close Thursday. Company Ticker Forecast* Year ago HP HPQ $0.64 $0.51 Dell DELL $0.24 $0.39 Source:* According to a consensus of analysts surveyed by Thomson Financial.

While that discovery has tarnished the Silicon Valley legend's reputation, HP's (Charts) stock hasn't taken a tumble on the news. On the contrary, shares of HP have soared 10 percent since the scandal surfaced in September.

In fact, the stock, which has surged about 41 percent so far this year, is at a six-year high. The rise has been helped by turnaround efforts implemented by new CEO Mark Hurd as well as trouble at top rival Dell, whose shares have tumbled 15 percent in 2006.

After years of posting lackluster earnings, HP's profits have grown under Hurd, who stepped in as CEO in April 2005. The company has steadily beat Wall Street's estimates and aims to keep up the winning streak when it reports fiscal fourth-quarter results after the market close Thursday.

"The HP story still looks good. They're on top of their game in all their products and restructuring is still helping profitability," said Mark Lanyon, an equity analyst at Morningstar.

Besides aggressively cutting costs, Hurd has helped HP grow its share of the PC market.

In the calendar third quarter, HP reclaimed the No. 1 spot in the worldwide PC market from Dell. It was the first time HP had regained the lead since 2003, according to research firm Gartner.

The company also is holding its own in the printing business. And that division contributes the most to HP's operating earnings.

While a solid quarter is expected from HP, some investors are nervous about the health of the sector.

Last week, No. 3 computer maker Lenovo (Charts), which bought IBM's (Charts) PC business last year, said its profit slumped in the latest quarter amid stiff competition and slowing demand for PCs worldwide.

"Lenovo provided a scare for folks. Now the question is how is the rest of the industry doing?" said Mark Mowrey, an analyst at Al Frank Asset Management, which owns shares of HP.

For the record, Wall Street analysts are expecting HP's earnings per share, excluding one-time items, to surge 25 percent to 64 cents a share from the year-ago period. Revenue is forecast to grow 5 percent to $24.1 billion for the quarter ended Oct. 31.

Dell (Charts), the second-largest PC maker also was due to report after the market close Thursday, but said late Wednesday that it was delaying its report until as late as the end of November.

Analysts expect Dell's earnings per share to sink 38 percent from the year-ago period to 24 cents a share. Revenue is expected to edge higher by 4 percent to $14.4 billion.

Shaw Wu, an analyst at American Technology Research, expects HP to turn in an overall strong quarter.

HP is well positioned in the fast-growing laptop segment and its international sales show strength, he said. HP's growing services business, however, could show some weakness, he added.

Wu also expects the company to issue an upbeat forecast for the January quarter.

"We think guidance is going to be good because they're going to add the Mercury deal, which has a lot of room for cost reduction," he said, referring to the $4.5 billion acquisition of software firm Mercury Interactive which HP closed earlier this month.

While HP's turnaround appears to be humming along, some investors and analysts are concerned about the company's longer-term prospects.

Although earnings have increased at a rapid clip, sales growth has remained in the single digits and shows few signs of accelerating, analysts said. And as HP approaches $100 billion in revenue a year, it becomes even harder for it to grow its top line.

The launch of Vista, the latest update to Microsoft's (Charts) operating system, could also help spur consumer demand for PCs in 2007, but analysts said it could take longer for corporations to upgrade their systems.

"We know long-term it takes a while for a new operating system to gain momentum, and many corporations have only just begun the transition to XP," Mowrey said.

Microsoft is launching Vista to business customers at the end of this month and to consumers in January.

Analysts say HP's profitability also is likely to come under pressure once cost-cutting measures run their course. Wall Street analysts expect earnings growth to slow to 14 percent this fiscal year, down from 34 percent in fiscal 2006.

And with the run the stock has had, some feel it's gotten too pricey.

HP trades at nearly 16 times analysts' estimated earnings for calendar 2007. That's a discount to Dell, but more expensive than IBM, which trades at 14 times 2007 earnings estimates.

"I don't think it's a compelling valuation right now," Morningstar's Lanyon said. But as long as investors believe increased productivity will keep driving earnings momentum over the next year, shares could keep rising, he added.

Neither Lanyon or Wu own shares of HP, but Mowrey does. None of the analysts' companies mentioned in this story provide investment banking services for HP.

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