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Hewlett Packard Enterprise: Risks Outweigh Transformation Story
Stock Analysis & Ideas

Hewlett Packard Enterprise: Risks Outweigh Transformation Story

San Jose-based Hewlett Packard Enterprise (HPE) is a B2B-focused company with two main segments: Enterprise Group, which is involved in servers, storage, networking, consulting and support, and Financial Services.

HPE was spun-off from the original HP Inc. (HPQ). The original HP company has retained its P.C. and printing business, while the spun-off company concentrates on new technologies in the B2B digital infrastructure space.

HPE has been on a journey to grow its cloud business in an attempt to compensate for the stagnated legacy businesses. While cloud revenues have been indeed growing, I believe the stock’s investment case is hardly compelling. I am neutral on the stock.

Latest Developments

HPE’s latest results came in rather mixed. In Q1 2022, revenues rose by just 2% year-over-year to $6.96 billion. Fortunately, HPE’s Cloud segment posted an annualized revenue run-rate (ARR) of $798 million, suggesting a 23% increase year-over-year. However, the company’s core businesses performed relatively softly.

Particularly, Compute revenues came in at $3 billion, just 1% higher compared to last year, while Storage revenues fell by 3% to $1.2 billion.

The Financial Services segment also reported underwhelming results, recording $842 million in revenues, suggesting a 2% decline from the prior-year period.

With increased expenses somewhat offsetting the growth achieved in Cloud, Q1 2022 non-GAAP EPS was $0.53, just a cent higher year-over-year.

Management adjusted its guidance for the year ahead, forecasting Q2 2022 non-GAAP diluted net EPS to be in the range of $0.41 to $0.49, and FY 2022 non-GAAP diluted net EPS to land between $2.03 and $2.17.

Capital Returns

HPE’s bottom line has been under pressure since the spin-off, but EPS has remained relatively steady, powered by enormous buybacks. 

While HPE has been paying an annual DPS of $0.48 for a couple of years now, the company has prioritized share buybacks over dividend growth. This is likely due to buybacks being a more effective way to reward shareholders. With the stock’s valuation multiple often in the single digits, HPE has been able to retire a huge chunk of its stock on the cheap.

Over the past seven years, HPE has repurchased around 27.7% of its stock. Hopefully, as HPE expands the cloud’s ARRs, its profitability should be less reliant on its legacy segments and buybacks to sustain its current EPS levels.

Wall Street’s Take

Turning to Wall Street, Hewlett Packard Enterprise has a Moderate Buy consensus rating, based on five Buys, four Holds, and one Sell assigned in the past three months.

At $17.80, the average Hewlett Packard Enterprise stock projections suggest 4.5% upside potential.

Conclusion

Based on the midpoint of management’s FY 2022 non-GAAP EPS guidance, the stock is currently trading at a forward P/E of 8.1. While this may seem like an inexpensive multiple, there are multiple risks attached to the company. The legacy businesses are likely to continue to see their revenues gradually decline.

Further, the Cloud business only accounts for roughly one-tenth of the company’s total revenues, and considering how competitive the space is – filled with tech behemoths fighting for market share – HPE may not have a chance to meaningfully grow its ARR cloud revenues over the long run. Consequently, it makes sense why the market remains wary of HPE’s investment case.

Overall, I believe there are better companies to allocate capital for exposure in the cloud, despite HPE’s seemingly attractive valuation.

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