Computer Hardware: Recession-Proof?

Demand for PCs is holding up even as the U.S. economy slumps, says S&P analyst Tom Smith

When the U.S. economy slumps, computer and other hardware sales usually follow suit. That's not happening this year. "It's surprising that PC sales have held up," says Tom Smith, who follows computer hardware stocks for Standard & Poor's Equity Research. "There's something strong about people and their connection to their laptops."

The latest evidence came from the Aug. 19 earnings report from Hewlett-Packard (HPQ), which said unit shipments of PCs rose 20% from a year ago. This indicates the strong trends in the industry are continuing, Smith says, as consumers and businesses keep buying new laptops with more power, memory, and battery life to manage even more tasks, including storing photos, movies, and music. Faster growth in developing countries is helping offset weakness in U.S. sales for most hardware makers, he adds.

"PC sales just didn't falter in the first half of 2008," Smith says. "They should have failed already if they were going to."

In turn, shares of computer makers are not suffering as much as the broader market this year. Year-to-date through Aug. 15, the S&P Computer Hardware index fell 2.1%, vs. an 11.6% decline for the S&P 500 index. In 2007, the sub-industry index jumped 32.6%, compared with a 3.5% rise for the S&P 500.

BusinessWeek.com's Karyn McCormack spoke with Smith on Aug. 21 about the outlook for computer makers and his favorite stocks. Edited excerpts follow.

Hewlett-Packard reported a good July quarter. What does that indicate for other computer hardware makers in the coming quarters?

It was a pretty strong quarter—a key thing for HP is that unit sales for PCs were up 20%. What I see here is a continuation of some trends. Overall unit shipments of PCs globally remain strong, with almost 15% growth last year and projected to be as strong this year. With average selling prices falling, the dollar revenue rise should be less than that, nearly 10%, according to IDC. The U.S. economy has moderated, and sales of PCs have been slower. But in far-flung geographies—such as Asia-Pacific, Middle East, and Africa—sales are stronger, and it seems that is helping to offset weakness in the U.S.

In PCs, notebooks continue to grow faster than desktops. In its July quarter, HP said notebook revenue rose 26% from a year ago, while desktop revenue grew 6%. HP's unit shipments rose 20%, while revenue rose 15% for its personal systems group.

In HP's printers and imaging business, revenue grew 3% from a year ago to $7 billion—to me it's a hopeful sign that it grew at all. It's surviving a slowdown in the U.S. economy and managed to show positive growth. In this area, the hardware revenue fell for both consumer and commercial customers, while supplies revenue grew 11%. So even if hardware sales go down, people still need ink and supplies.

In HP's enterprise storage and servers, revenue was $4.7 billion, up 5% from a year ago. So it hasn't really slowed down. Blade servers are a huge growth area—they're a smaller, more energy-efficient way to perform certain server tasks.

HP software revenue grew 29%, which may reflect some consulting business. For HP, overall, you can say that all segments contributed to growth, which is a powerful statement considering the U.S. economy slowing. Cost cuts helped the company beat the consensus EPS forecast by a few pennies.

My principle takeaway from HP is that PC unit sales remain strong, and my summation from the rest of the industry is that all PC makers are participating. We've seen very strong growth from Apple (AAPL), but you've also seen Dell (DELL) growing from a new distribution plan that includes partnerships with a few retailers. Dell reports results on Thursday, Aug.