HP’s China problem

Signs of rapidly worsening Chinese demand for IT giants IBM and Cisco Systems Inc are starting to spook Hewlett-Packard investors.

HP’s year-long stock rally sputtered last week amid fears a faster-than-anticipated slowdown in emerging markets, above all China, may dash the computing giant’s hopes for a return to growth in 2014 or beyond.

Cisco has warned about crumbling Chinese demand. IBM last month reported a sales drop of over 20 percent in the world’s No. 2 economy.

Both also reported weakness in other emerging markets as well, but it was China and concerns about sales declines in that market that has grabbed headlines.

HP is already grappling with expectations of slowing U.S. federal spending, a fundamental erosion of PC demand and unrelenting competition from Lenovo and Dell. So it can ill afford a steeper-than-expected dropoff in China, which is estimated to account for a fifth of HP’s revenue and is one of its most crucial growth markets.

Investors are looking to the computing giant, which reports quarterly results on Tuesday, to shed more light on goings-on in the world’s largest PC market.

“All the giant tech companies are somewhat at risk now. You have to worry if the other companies are going to report the same kind of thing in their fourth quarter,” said Peter Tuz, President of Chase Investment Counsel Corp in Virgina.

Shares in HP, up 77 percent so far this year, have lost almost 5 percent in the week since Cisco blamed a dismal business outlook on deepening fallout from the Snowden revelations. Some analysts also blame competition from networking giant Huawei and the government’s increasing tendency to buy local.

Mizuho Securities analyst Abhey Lamba cited another culprit: a slowdown in spending by Chinese state enterprises awaiting policy signals from a new government.

Microsoft said China was the company’s weakest performing market during the September quarter. The picture is far from clear, however. Juniper Networks said last week its business continues to grow in Asia, including China.

Servers, personal computers

Weaker Chinese demand could throw up a new obstacle to HP’s efforts to reverse years of revenue declines. Whitman told investors last month she expects revenue to stabilize in 2014 with “some areas of growth”, before the business accelerates again in 2015.

Immediate challenges include soft consumer PC demand and pricing pressure from a newly private Dell, which is aggressively marketing its servers and PCs. HP is also losing market share to Asian rival Lenovo, which is focusing on traditional HP strongholds like North America and Europe.

Investors hope improvements in execution and better-than-expected demand for Hewlett-Packard’s big data, security and cloud offerings can eventually prop up the top line.

Goldman Sachs Group recently advised clients to buy December $24 strike put options on HP as a hedge against poor earnings.

Wall Street analysts expect HP to earn $1 per share, with revenue seen down 7 percent to $27.9 billion in its fiscal fourth quarter, according to Thomson Reuters I/B/E/S.

“We see risk of downward consensus estimate revisions following the earnings event,” their strategists said in a Weekly Options Watch report issued on November 20.

To be sure, HP has the benefit of low expectations: even a small beat on Tuesday could ignite a rally given IBM’s and Cisco’s twin disappointments. Some fund managers are looking at any pullback as a buying opportunity.

“I am really interested and intrigued with the earnings next week,” Chris Bertelsen, Chief Investment Officer at Global Financial Private Capital, a Florida-based wealth manager that sold its position following HP’s run-up.

Bertelsen said he may buy the stock back if it falls further, and if management remains disciplined on acquisitions.

“I would be willing to take a smaller position in it, with the idea being that the transformation will happen,” he said.

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HP’s China problem