A Glimpse into Hewlett Packard Enterprise (HPE) Challenges

As HPE's competition has odds to just get more fierce, Susquehanna Mehdi Hosseini shares his takeaways from the tech giant's FQ2:18 show from the sidelines.

Hewlett Packard Enterprise Co (NYSE:HPE) got tripped up by its third fiscal quarter guide despite revenue growth exhibited in its second fiscal quarter of 2018. In reaction, underwhelmed investors are sending a message as HPE shares crash 10% today.

Susquehanna analyst Mehdi Hosseini wonders whether value can eventually take volume’s place, sizing up “a race against time to stimulate high margin biz.” For now, it continues to be hazy to the analyst if the tech giant is capable of generating a product strategy that is both “balanced” as it is “diverse;” a key in aiding top-line gains as well as a compelling gross margin profile.

“With competition intensifying, Op margin trends disappointing, all while compares are becoming challenging when looking into 2HFY18, we wonder whether aggressive buyback (instead of M&A) is the most prudent L-T strategy. In this context, while we believe HPE’s aggressive buyback program (~ $1.9B planned for 2HFY18) will provide some downside support, we believe strategic M&A (yes, more of it) may be necessary for HPE to reinvent itself towards a higher growth and a more balanced margin profile for the L-T,” notes Hosseini.

As such, the analyst reiterates a Neutral rating on HPE stock with a $17 price target, which implies a close to 9% upside from current levels, reflecting some positivity amid Hosseini’s concerns that keep him planted on the sidelines. (To watch Hosseini’s track record, click here)

Though the third fiscal quarter outlook proved to disappoint, the giant’s second fiscal quarter results outclassed expectations. HPE posted $7.47 billion in revenue and $0.34 in EPS, beating out the analyst’s forecasts calling for $7.24 billion in revenue and $0.31 in EPS as well as the Street’s expectations of $7.39 billion and $0.31. Additionally, the company served up 30.4% in gross margins, beating out the analyst’s 29.3% estimate as well as consensus of 29.8%. Operating margins hit 8.6% against the analyst’s expectations of 8.8% and consensus of 8.5%. However, HPE hit -$269 million in negative free cash flow against Hosseini’s expectations of $388 million.

The company guided for $0.35 to $0.39 in EPS for the third fiscal quarter against the analyst’s and the Street’s $0.36 estimates, which has come across lackluster to Wall Street. Moreover, the HPE team bumped up its fiscal 2018 EPS guide from a prior range of $1.35 to $1.45 up to $1.40 to $1.50 against the analyst’s and the Street’s $1.41 projection.

On back of the print, Hosseini lifts his fiscal 2018 revenue forecast from $29.68 to $30.46 billion and EPS from $1.40 to $1.45. Additionally, the analyst sets new targets for fiscal 2019, expecting revenue to hit $30.21 billion against the Street’s $30.8 billion and EPS to reach $1.50 compared to the Street’s $1.49 estimate.

When the landscape rife with rivalry is primed to get more intense, the analyst doubts the company can achieve its opening target to hit 9.5% in operating margins for fiscal 2018, particularly if end-market demand starts to ease. Hosseini questions whether the giant’s value solutions can grow at a quick enough pace to make up for low margin mix growth. Meanwhile, as foreign exchange transitions away from being an advantageous tailwind and with acquisitions “lapping,” the HPE team calls for the back half of fiscal 2018 growth to be a far greater obstacle. Even with robust end market demand for the company’s Server segment, Hosseini points out this has a cost: low margins, weighing down on HPE’s capacity to fulfill its fiscal 2018 margin target.

Hosseini sheds light on his final standout insights from HPE’s quarterly showcase: “1) we estimate HCI + Synergy can get to a $1.3B annualized run rate exiting FY18, which would make up ~10% of overall Compute Revenue, 2) Storage came in stronger than expected (14% Y/Y organic growth), but 2HFY18 growth likely to decelerate to high-single digits, 3) Apr Q FCF came in softer than expected, though HPE reiterated it’s $1B FCF target (partly achieved by real estate sales we believe can come in at ~$100M-$200M).”

TipRanks reveals a general wariness circulating HPE stock, but with a healthy amount of optimism baked into target expectations. Out of 8 analysts polled in the last 3 months, 2 are bullish on the tech giant, a majority of 5 remain sidelined, while 1 is bearish on the stock. With a solid return potential of 27%, the stock’s consensus target price stands at $19.88.

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