Report
Mark Cash
EUR 850.00 For Business Accounts Only

Morningstar | Hybrid IT and Intelligence Edge Weakness Drag HPE's 2Q; Maintaining FVE of $15

No-moat Hewlett Packard Enterprise's 4% year-over-year revenue decline was below our expectations but the company's surprised on margin improvements. Weakness in compute, HPE Pointnext, Aruba products, and HPE financial services led to a year-over-year revenue decline of 4%. Gross margins increased 180 basis points year over year to 32.2%, which was led by favorable commodity component costs and selling higher margin products like high performance compute and hyperconverged infrastructure. Lower operating expenses and gross margin expansion increased operating margin by 120 basis points year over year to 6.1%. Although we believe HPE has positive momentum in high growth areas, like all-flash arrays, and that Aruba should turn around with Wi-Fi 6 products, we are maintaining our fair value estimate of $15 per share as we expect HPE to continually face pressure from its peers alongside customers shifting away from HPE's IT products for public cloud. We advise investors to wait for wider margin of safety for this name.

Compared with last year, hybrid IT shrank by 4% with compute declining by 5%, storage increasing by 3%, and HPE Pointnext declining by 7%. HPE continues to purposely decrease its sales to the large public cloud providers and those sales now only represent 1.9% of revenue (5% a year prior). Management commented that the hybrid IT division suffered from execution issues and unexpected market dynamics. The company will be realigning its sales efforts after posting poor results in North America. We were surprised by the 6% decrease in Aruba product sales, which was blamed on resources not being properly aligned and an elongated sales cycle. In our view, Aruba moving to Wi-Fi 6 products should spur growth, but we believe competitors like Cisco may have beat HPE to the next wave of wireless. We posit the company is making wise moves by focusing on higher-margin geographies and product families, which we expect to continue showing up in its financials.

HPE increased its 2019 earnings outlook by raising its GAAP EPS guidance to $0.98-$1.08 from $0.88-$0.98 (non-GAAP EPS increased to $1.62-$1.72 from $1.56-$1.66). We believe these targets are obtainable as HPE continues to decrease its presence in cost competitive markets, lowers its sales to the hyperscale cloud providers, and grows in areas like all-flash array storage, wireless products, and cloud services.

HPE announced its intention to purchase supercomputer manufacturer Cray in the quarter. As we indicated in our note about the Cray acquisition announcement, we view the acquisition positively. In the high performance-compute market, Hewlett Packard Enterprise mostly sells into enterprises with mid-tier products while Cray sells high-end solutions that have been government-centric. As data continues to expand exponentially and faster processing of enormously large and complex data sets is required, we believe Hewlett Packard Enterprise has gained technology it can integrate into enterprise solutions and its scale can help Cray's profitability and customer reach.
Underlying
Hewlett Packard Enterprise Co.

Hewlett Packard Enterprise is a technology company. The company's segments are: Hybrid IT, which provides a portfolio of infrastructure and solutions including servers, storage, and HPE Pointnext services; Intelligent Edge, which is comprised of cloud solutions that include wireless local area network, campus and data center switching, software-defined wide-area-networking, security, and associated services to enable secure connectivity; Financial Services, which provides investment solutions for customers that facilitate technology deployment models; and Corporate Investments, which includes Communications and Media Solutions, Hewlett Packard Labs and certain business incubation projects.

Provider
Morningstar
Morningstar

Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. The company offer an extensive line of products and services for individual investors, financial advisors, asset managers, and retirement plan providers and sponsors.

Morningstar provides data on approximately 530,000 investment offerings, including stocks, mutual funds, and similar vehicles, along with real-time global market data on more than 18 million equities, indexes, futures, options, commodities, and precious metals, in addition to foreign exchange and Treasury markets. Morningstar also offers investment management services through its investment advisory subsidiaries and had approximately $185 billion in assets under advisement and management as of June 30, 2016.

We have operations in 27 countries.

Analysts
Mark Cash

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