HP Inc. (NYSE:HPQ)

The period under review demonstrates a volatile financial performance as measured by economic profit. Initially, the company experienced substantial economic losses, which gradually diminished before turning into modest economic profits in the later years of the observed timeframe.

Net Operating Profit After Taxes (NOPAT)

NOPAT began at US$4,258 million in 2013, increased to US$4,693 million in 2014, then declined significantly to US$3,947 million in 2015 and further to US$2,997 million in 2016. A slight recovery to US$3,064 million occurred in 2017, followed by a substantial decrease to US$2,027 million in 2018. This indicates a general downward trend in operational profitability over the period.

Cost of Capital

The cost of capital fluctuated considerably. It rose from 19.01% in 2013 to 21.01% in 2014, then decreased substantially to 13.47% in 2015. It subsequently increased to 21.25% in 2016 and 21.70% in 2017, culminating in a further increase to 22.72% in 2018. The increasing cost of capital in the latter years likely contributed to the challenges in achieving economic profitability.

Invested Capital

Invested capital decreased from US$67,461 million in 2013 to US$65,787 million in 2014, then increased to US$71,569 million in 2015. A dramatic reduction occurred in 2016 to US$9,027 million, followed by a slight increase to US$9,763 million in 2017, and a further decrease to US$7,561 million in 2018. The significant decline in invested capital from 2015 to 2016 is a notable observation and warrants further investigation.

Economic Profit

Economic profit was negative for the first three years of the period, starting at -US$8,568 million in 2013, worsening to -US$9,132 million in 2014, and improving slightly to -US$5,694 million in 2015. A positive economic profit of US$1,080 million was achieved in 2016, followed by US$945 million in 2017 and US$309 million in 2018. The transition from economic loss to economic profit suggests improved capital allocation efficiency or a reduction in the cost of capital relative to returns, although the profits remained relatively modest in the final two years.

The interplay between NOPAT, cost of capital, and invested capital significantly influenced the economic profit. While NOPAT generally declined, the reduction in invested capital, particularly after 2015, appears to have played a crucial role in the eventual achievement of positive economic profit. The increasing cost of capital in the later years, however, presents a potential headwind to sustaining these gains.

Net earnings

Net earnings displayed a downward trend from 2013 through 2016, decreasing from 5,113 million US dollars in 2013 to a low of 2,496 million US dollars in 2016. This was followed by a period of relative stability with a slight increase to 2,526 million US dollars in 2017. In 2018, net earnings sharply rebounded to 5,327 million US dollars, surpassing the 2013 figure.

Net operating profit after taxes (NOPAT)

NOPAT witnessed a decline during the same initial period, dropping from 4,258 million US dollars in 2013 to 2,997 million US dollars in 2016. There was a modest recovery in 2017, reaching 3,064 million US dollars. However, contrary to net earnings, NOPAT decreased significantly in 2018 to 2,027 million US dollars, marking the lowest value in the observed range.

Overall Analysis

The data reveals diverging trends between net earnings and NOPAT in 2018. While net earnings showed a strong recovery, more than doubling relative to the previous year, NOPAT declined sharply, indicating potential changes in operational efficiency, tax effects, or non-operating income components affecting the profitability metrics differently. The earlier period from 2013 to 2016 demonstrates a consistent decline in both metrics, possibly pointing to operational challenges or adverse market conditions during those years.

Provision for (benefit from) taxes on earnings

The provision for taxes on earnings exhibits significant volatility over the observed period. Starting at $1,397 million in 2013, it increased to $1,544 million in 2014, followed by a sharp decline to $178 million in 2015. In 2016, the amount rose again to $1,095 million, then decreased to $750 million in 2017, before turning into a substantial tax benefit of -$2,314 million in 2018. This fluctuation indicates variability in the company's taxable income or changes in tax strategy and tax regulations over the years.

Cash operating taxes

Cash operating taxes show a general downward trend from 2013 to 2017, decreasing from $1,924 million to $612 million. However, there is a notable rebound in 2018 with an increase to $1,398 million. This trend suggests a gradual reduction in actual cash tax payments over the first five years, possibly due to tax planning or changes in profitability, followed by a significant rise in the final year, which could reflect an increase in taxable cash flows or changes in tax payments timing or policies.

Total reported debt & leases

The total reported debt and leases exhibited a fluctuating pattern over the analyzed period. Starting at 25,193 million US dollars in 2013, the figure decreased to 22,206 million in 2014, followed by an increase to 27,126 million in 2015. Subsequently, there was a sharp decline to 7,737 million in 2016, with minor increases to 8,855 million in 2017 and a decrease again to 7,247 million in 2018. This indicates a significant reduction in debt levels from 2015 onwards, possibly reflecting a strategic deleveraging or asset restructuring effort.

Total HP stockholders’ equity (deficit)

Stockholders’ equity showed stability and slight growth from 27,269 million in 2013 to 27,768 million in 2015. However, from 2016 onwards, the equity balance turned negative, indicating a deficit position of -3,889 million in 2016. This deficit slightly improved but remained negative at -3,408 million in 2017 and -639 million in 2018. The transition to negative equity suggests significant losses or charges affecting retained earnings or valuation adjustments during this period.

Invested capital

Invested capital remained relatively stable and showed a mild upward trend from 67,461 million in 2013 to 71,569 million in 2015. Beginning in 2016, there was a sharp and substantial drop to 9,027 million followed by a slight increase to 9,763 million in 2017 and a decrease again to 7,561 million in 2018. The dramatic decline post-2015 aligns with reduced debt levels and negative equity, possibly reflecting a divestiture of significant assets or a fundamental change in capital structure.

The economic spread ratio exhibited a significant improvement over the observed period. Initially negative, the ratio transitioned to positive values, indicating a strengthening of the company’s ability to generate returns exceeding its cost of capital. This improvement is closely linked to the fluctuations in economic profit and invested capital.

Economic Spread Ratio Trend

From 2013 to 2014, the economic spread ratio declined from -12.70% to -13.88%, suggesting a worsening of profitability relative to invested capital. A substantial improvement followed, with the ratio increasing to -7.96% in 2015. The most dramatic shift occurred between 2015 and 2016, when the ratio became positive at 11.96%. This positive trend continued, though at a decelerating rate, reaching 9.68% in 2017 and 4.08% in 2018.

The economic spread ratio’s movement mirrors the changes in economic profit. While economic profit remained negative for the first three years of the period, it turned positive in 2016, coinciding with the ratio’s shift into positive territory. However, the magnitude of the improvement in the economic spread ratio outpaced the growth in economic profit, particularly between 2015 and 2016, suggesting a significant change in the efficiency of capital utilization.

Relationship with Invested Capital

Invested capital decreased considerably from 2013 to 2018. The most substantial reduction occurred between 2015 and 2016, falling from US$71,569 million to US$9,027 million. This decrease in invested capital, coupled with the eventual positive economic profit, contributed to the increasing economic spread ratio. The continued decline in invested capital from 2017 to 2018, while economic profit remained positive, further supported the ratio’s positive, albeit diminishing, trend.

The observed trend suggests a strategic shift towards more efficient capital allocation and improved profitability. The company’s ability to generate positive economic profit, combined with a decreasing capital base, resulted in a substantial increase in the economic spread ratio, indicating enhanced value creation.

The economic profit margin exhibited a clear improving trend over the observed period. Initially negative, the metric progressed towards positive values, albeit with diminishing gains in later years.

Economic Profit Margin

In fiscal year 2013, the economic profit margin stood at -7.66%. This indicates that the company’s economic profit was negative, meaning the return generated was less than the cost of capital employed. The margin worsened in 2014, reaching -8.22%, suggesting a further decline in value creation relative to capital costs.

A significant improvement occurred between 2014 and 2016. The economic profit margin increased to 2.24% in 2016, signifying that the company began generating economic profit. This positive shift coincided with a substantial decrease in adjusted net revenue between 2015 and 2016.

The rate of improvement slowed in subsequent years. The margin reached 1.81% in 2017 and further decreased to 0.53% in 2018. While remaining positive, the diminishing margin suggests that the company’s ability to generate returns exceeding its cost of capital was becoming constrained, despite increasing adjusted net revenue in 2017 and 2018.

The progression from negative to positive economic profit margins demonstrates a positive change in the company’s financial performance. However, the decelerating improvement in the margin from 2016 onwards warrants further investigation to understand the underlying factors influencing value creation.

Relationship to Adjusted Net Revenue

The economic profit margin’s improvement from 2013 to 2016 occurred during a period of declining adjusted net revenue. This suggests that improvements in operational efficiency or cost management played a crucial role in shifting the company to economic profitability, rather than revenue growth.

The subsequent slowdown in margin improvement, coupled with revenue increases in 2017 and 2018, indicates that revenue growth alone was insufficient to maintain the pace of economic profit margin expansion. This could be due to increased costs associated with generating the additional revenue or a less favorable shift in the revenue mix.