With Hewlett-Packard (NYSE:HPQ) shares up almost 100% from the November 2012 lows, it seems pretty clear that Wall Street has bought into the company's plans to cut costs and enhance free cash flow (FCF). Moreover, investors are clearly happy to see HP emerge as one of the very few tech companies to not only meet (or exceed) estimates but actually raise guidance for the next quarter. While that's certainly all positive, HP still has significant issues with competitiveness that must be favorably resolved before the true underlying value in these shares comes to fruition.

SEE: Earnings Guidance – Can It Accurately Predict The Future?

Fiscal Second Quarter Results Come Through On Margins
It seems appropriate for HP that this fiscal second quarter was a complicated mix of good and bad news. The company is certainly making progress on its cost-cutting and restructuring initiatives. At the same time, the company's decision to focus on profitability is having a definite impact on revenue.

Revenue fell 10% this quarter (and 3% from the prior quarter), a minor miss relative to the average sell-side estimate. While the magnitude of the miss was small, the performance was pretty uniform across the segments with no real sources of strength.

Margins were a better story. Gross margin improved half a point from last year. Operating income fell 13%, but the 8.6% adjusted operating margin was better than expected as the company's restructuring efforts start to pay off. Although the segment margin for the printing business was a little weaker than most analysts expected (but up from last year), the other segments came in pretty strong relative to expectations.

SEE: How To Decode A Company’s Earnings Reports

Tough Markets And Tough Decisions Impacting Revenue
Revenue in HP's printer and PC business fell 12% this quarter, with a 20% drop in PC revenue pacing the decline. Although this is a lousy market for PCs, HP continues to do notably worse than the market leader Lenovo (OTC:LNVGY) (where PC sales were down just slightly for the quarter). Some of this appears to be due to a newfound respect for profitability, as HP walked away from low-margin business and Asian rivals like Lenovo are generally willing to accept lower margins from this market.

The 10% decline in enterprise group revenue is a little more concerning, though. While networking revenue was up 1%, server revenue fell 12% and storage was down 13%. Elsewhere, tech services revenue declined 3% and “Business Critical Systems” revenue declined 37%. The decline in servers is not altogether surprising given the reports from rivals like IBM (NYSE:IBM), but I do wonder what it says about the company's competitiveness and ability to execute in the market. Likewise for storage; while I accept that HP is seeing ongoing declines in the legacy business that are overshadowing progress at 3PAR, I question whether the company can really make headway against EMC (NYSE:EMC) or NetApp (Nasdaq:NTAP) with its all-flash offerings and/or by targeting the mid-range of the market.

Competitiveness and execution are likewise still real concerns in software (where revenue declined 3%) and services (down 8%). With the reports from companies like IBM and Oracle (Nasdaq:ORCL) in hand, it's pretty clear that HP is not alone in seeing challenging times, but the company continues to underperform its larger rivals.

It's All About Execution
Cutting costs and restructuring operations is all well and good, but it won't grow HP's business for the long term. To that end, the opportunities for HP to grow with businesses like 3PAR and “Project Moonshot” (a server platform that demands considerably less power and space than traditional servers) have to be set against the numerous missteps and execution issues seen over the past couple of years. Likewise, driving out costs is certainly something that Wall Street likes, but if it comes at the cost of demoralizing and demotivating the sales force and/or choking off reinvestment into R&D, it's a self-defeating strategy over the long term.

SEE: R&D Spending And Profitability: What’s The Link?

The Bottom Line
I've maintained for some time that I believed HP would ultimately survive, and I continue to believe that. The company's software operations are not very competitive and the PC business is weak, but printing remains a valuable source of cash flow and I think the company's positions in storage and servers are undervalued even with all of the difficulties and revenue declines. As management continues to execute this turnaround plan, I expect HP to emerge as a somewhat smaller, but more focused and profitable tech conglomerate.

Even with the big rebound in the shares, HP is undervalued if it manages to grow at all. Long-term free cash flow growth of just 1% to 2% works out to a target price in the high $20s to low $30s. There's still the risk that sales and free cash flow decline further from here, but even no growth at all relative to fiscal 2012 free cash flow would point to a fair value in the mid-$20s. With that in mind, I think the easy money has been made on the HP recovery, but those investors who have confidence in management and its turnaround plan have reason to hang around in the hope of still more appreciation in the shares.

At the time of writing, Stephen D. Simpson owned shares of EMC.