HP stock looks cheap, but I’m not going to buy it for that reason

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That’s out of the question PS (NYSE: HPQ) looks like a value stock. The company expects to generate adjusted earnings of around $ 2.17 per share this year, which is a measly 9 / earnings ratio. That’s the kind of depressed rating that usually piques my interest.

But I’m not interested in investing in HP. The problem isn’t how much money the company makes; This is how the company makes its money. HP sells PCs, printers, and supplies for these printers. PCs make up the bulk of sales, but the printing business makes up the bulk of profits.

segment

Sales 2018

Operating profit 2018

Operating margin 2018

Personal systems

$ 37.7 billion

$ 1.41 billion

3.7%

To press

$ 20.8 billion

$ 3.32 billion

16%

Data source: HP.

In the printing sector, consumables make up around two thirds of total sales. HP is pursuing a razor-and-blade model for its printing business. It sells low-margin hardware that then needs a continuous supply of high-margin consumables. It’s safe to say that most of HP’s printing profits, and therefore the majority of total profits, come from sales of printing supplies.

Image source: HP.

A crack in the status quo

This model worked well for a long time. It’s not that people didn’t know that printing ink was expensive – it is human to fret about the high cost of printing ink. Rather, there were limited alternatives to buying supplies from everyone but HP, brick-and-mortar retailers, or HP resellers, especially in the commercial sector.

It has taken a while, but e-commerce now seems to be about to seriously disrupt HP’s printing supplies cash cow. HP reported a 3% year-over-year decrease in sales of printing supplies for the first quarter of fiscal. The company blamed commercial customers for increasingly relocating their purchases online, where HP has a smaller market share. Customers have also become more price sensitive, which puts pressure on asking prices.

Third-party ink cartridges aren’t new, but HP is having a harder time keeping up. CEO Dion Weisler stated during the first quarter conference call that the growth of e-commerce has allowed aftermarket manufacturers to invest in better technology faster than in the past, resulting in “a faster decline in our aftermarket stake on some newer ones Platforms as “we expected.”

I wouldn’t be overly concerned if HP’s price was just slightly higher than aftermarket alternatives. A commercial customer is not going to turn away from HP on supplies for little savings, especially considering that aftermarket supplies may or may not be of the same quality. But the savings are not small. HP loses heavily on pricing.

How much? For a list of the current prices for some ink and toner cartridges, visit HP.com and inkjets.com, a third party ink provider. The third-party cartridges are remanufactured but compatible with the specified models:

printer

cartridge

HP.com

Inkjet Printer.com

OfficeJet Pro 8710

952XL High yield black

$ 44.99

$ 18.95

Color LaserJet Enterprise M553dn

508X yellow with high yield

$ 321.99

$ 79.95

LaserJet Pro MFP M521DN

55X high yield black

$ 250.99

$ 34.95

Data sources: HP and inkjets.com.

On the consumer side, prices are also one-sided. Actually, Cost co offers ink cartridge refills in some locations starting at $ 6.99. The 952 XL Black cartridge in the previous table is refillable at Costco for $ 14.99.

This does not seem like a sustainable situation for HP to me.

View the latest results meeting minutes for HP.

Not a bet I want to make

Anyone who wants to invest in HP today has to bet that the status quo will largely be maintained for the foreseeable future. You have to assume that HP will continue to be able to inflate the price of printing supplies without losing much market share.

Given that HP is now admitting that online aftermarket sellers are a huge problem, that’s a leap of faith I just can’t take. To regain market share, lower prices will be required, and lower prices will lead to falling margins. This could seriously affect HP’s bottom line given its reliance on printing supplies.

Perhaps HP’s high-margin supplies business is more sustainable than it seems to me right now. If it does indeed go back, it may go back slowly enough to be offset by growth elsewhere, such as 3D printers.

Or maybe HP’s supplies business will be shut down for good. Razor-and-blade business models don’t seem to last forever. Just ask Gillette.

HP was surprised by online competition in the first quarter. If this is the start of a run in the printer supplies business, even a shabby valuation isn’t enough for me to want to buy the stock.

This article represents the opinion of the author who may disagree with the “official” referral position of a premium advisory service from the Motley Fool. We are colorful! Questioning an investment thesis – even one of our own – helps us all think critically about investing and make decisions that will help us get smarter, happier, and richer.


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