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, followed by a transition to positive economic profit in later years, though the magnitude of these profits diminished over time.

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, but NOPAT continued to decrease, reaching US$2,027 million in 2018. This indicates a general downward trend in operational profitability over the five-year period.

Cost of Capital

The cost of capital fluctuated considerably. It rose from 19.12% in 2013 to 21.14% in 2014, then decreased substantially to 13.54% in 2015. It subsequently increased again to 21.37% in 2016 and 21.83% in 2017, peaking at 22.86% in 2018. This suggests increasing financial risk and/or changing market conditions impacting the company’s funding costs.

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 decrease occurred in 2016 to US$9,027 million, followed by a slight increase to US$9,763 million in 2017, and a further decline to US$7,561 million in 2018. This substantial reduction in invested capital, particularly in 2016, warrants further investigation as it may indicate significant asset disposals or changes in capital structure.

Economic Profit

Economic profit was negative for the first three years of the period, starting at -US$8,641 million in 2013, worsening to -US$9,212 million in 2014, and improving to -US$5,745 million in 2015. A significant shift occurred in 2016, with economic profit turning positive at US$1,068 million. This positive trend continued in 2017 with a profit of US$932 million, but decreased to US$299 million in 2018. The transition from negative to positive economic profit suggests improved capital allocation efficiency, although the declining profits in the final two years indicate a potential erosion of this improvement.

The interplay between NOPAT, cost of capital, and invested capital significantly influenced economic profit. The initial negative economic profits were driven by a combination of relatively low NOPAT and a high cost of capital, coupled with substantial invested capital. The subsequent positive economic profits were likely due to a decrease in the cost of capital and a significant reduction in invested capital, despite a decline in NOPAT. The diminishing economic profit in 2017 and 2018 suggests that the benefits of reduced capital investment are being offset by declining operational performance.

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 shift over the observed period. Initially negative, the ratio transitioned to positive values, indicating an improving financial performance relative to the cost of capital. This improvement, however, appears to be decelerating in the most recent years.

Economic Spread Ratio Trend

From 2013 to 2014, the economic spread ratio declined from -12.81% to -14.00%, suggesting a worsening of returns relative to invested capital. A substantial improvement followed, with the ratio increasing to -8.03% in 2015. The period from 2016 onwards demonstrates a positive trend, reaching 11.84% in 2016 and 9.55% in 2017. However, the rate of increase slowed considerably, with the ratio decreasing to 3.95% in 2018.

The economic spread ratio’s movement closely mirrors the changes in economic profit. The negative economic profit values from 2013 to 2015 correspond with the negative economic spread ratios during those years. The positive economic profit reported in 2016, 2017, and 2018 is reflected in the positive economic spread ratios for those periods.

Relationship with Invested Capital

Invested capital decreased substantially from 2013 to 2018. While economic profit was negative for the first three years, the decreasing invested capital partially offset the negative economic profit, resulting in the improving, though still negative, economic spread ratios. The dramatic decrease in invested capital from 2015 to 2018, coupled with the move to positive economic profit, contributed to the higher economic spread ratios observed in the later years.

The deceleration in the economic spread ratio’s growth in 2018, despite continued positive economic profit, warrants further investigation. It suggests that while the company is generating returns exceeding its cost of capital, the efficiency of capital utilization may be diminishing or that the rate of improvement is slowing.

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 -7.73%. 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 -8.29%, suggesting a further decline in value creation relative to capital costs.

A significant improvement occurred in 2015, with the economic profit margin increasing to -5.53%. While still negative, this represents a substantial reduction in the shortfall between returns and capital costs. The trend continued positively, with the margin turning positive in 2016 at 2.22%, signifying that the company began generating returns exceeding its cost of capital.

The economic profit margin peaked at 1.79% in 2017, but experienced a decline in 2018, falling to 0.51%. This suggests a slowing in the rate of value creation, despite continued positive economic profit. The decreasing margin in the most recent year warrants further investigation to understand the underlying drivers.

The progression of the economic profit margin closely mirrors the fluctuations in economic profit itself. The initial negative economic profits corresponded with the larger negative margins, and the subsequent shift to positive economic profit aligned with the positive margin values. The adjusted net revenue also appears to influence the margin, as the largest revenue decline occurred between 2015 and 2016, coinciding with a decrease in the rate of margin improvement.

Overall, the period demonstrates a positive trajectory in value creation, moving from substantial economic losses to modest economic profits. However, the recent deceleration in margin improvement suggests potential challenges in sustaining this positive trend.