Hewlett Packard Enterprise: Strong dividend yield but weak growth (NYSE: HPE)
Hewlett-Packard Enterprise Company (NYSE: HPE) is an information technology company headquartered in Spring, Texas. In this thesis, I will analyze the impact of HPE’s exit from Russia and Belarus and its outperformance by the HPE Intelligent Edge Segment. I will also discuss some of the risks that HPE currently faces, including lower revenue growth in certain segments. HPE is a great edge-to-cloud company and has seen strong backlog growth over the past few quarters, but after considering all risk factors and future prospects, I’m giving a rating of retention at HPE.
HPE has ranked its activity in six segments: Intelligent Edge, HPC & AI, Compute, Storage, Financial Services and Corporate Investments. These different business segments operate under unique brands or platforms. Intelligent Edge operates under the Aruba brand and provides businesses with wired and wireless local area networking (LAN), software-defined wide area networking, and network security. HPC & AI provides hardware as well as software solutions that can be customized according to customer requirements.
HPE Apollo and Cray are the main brands under which HPC & AI operates. Compute is HPE’s largest segment by revenue; he is responsible for managing and optimizing the workload for high-performance applications. The compute business operates through HPE ProLiant servers and provides services to complement workload optimization. The storage segment provides storage as a service through the HPE GreenLake edge-to-cloud platform. I think the storage business has great potential in the future, given the heavy reliance of organizations on data. Financial services and corporate investment are primarily advisory and consulting segments that help companies invest and manage their costs.
The calculation occupies majority of revenue share at 44%, followed by Storage at 16%, Intelligent Edge at 13%, Financial Services at 12%, HPC & AI at 10%, and Corporate Investment at 5%. HPE believes that Intelligent Edge’s share will increase in the future, given the strong demand it has experienced in recent quarters. In terms of geographic revenue split, North America leads with 39%, followed by EMEA at 37% and Asia-Pacific and Japan at 24%.
Impact of the cessation of operations in Russia and Belarus
At the end of February, HPE suspended the delivery of products to Russia and Belarus due to the Russian-Ukrainian conflict at the time. June 1stHPE has issued an official statement confirming the cessation of operations in Russia and Belarus. HPE reported $126 million of charges and expenses related to this exit in Q2 2022, and management expects lower charges in Q3 2022 related to the exit from Russia and Belarus.
According to my analysis, the impact of this exit was not significant, but it still caused a decline of approximately $0.3 to $0.4 per share in the company’s EPS, which corresponds to 10% of BPA reported by HPE. The Russian-Ukrainian war not only caused a loss of income for Russia but also for European countries due to the economic downturn throughout Europe, mainly due to this war. I expect the Q3 impact due to the exit of Russia and Belarus to be in the range of $0.3 to $0.5 per share, but we have to wait for the announcement of the results officials, then I can analyze the impact in detail.
Smart edge outperformance
Intelligent Edge posted robust 9% growth in Q2 2022, and the order pipeline grew 35% from Q2 2022. I expect Intelligent Edge to take an even bigger revenue share over the next FY23 due to the as-a-service model being implemented by HPE to grow its customer base. Under this model, customers will only pay for the services they use instead of paying for the full package. This strategy will help HPE expand its market presence by reducing the cost burden for customers. According to my analysis, intelligent Edge currently has gross margins, which can be as high as 15.5% from the fourth quarter of 2022, given the positive response and growth of the Intelligent Edge as-a-service model.
Additional positive features
Strong dividend yield: HPE said a $0.12 dividend per share in the second quarter of 2022. At the current price, the dividend is 3.45%. The company has been consistent in paying dividends over the past few years. Even at the current level, the dividend yield looks attractive. I believe there is room for dividend growth in FY23 as margins improve with improving sourcing as well as material sourcing costs.
Increase in orders: HPE announced the fourth consecutive quarter with a 20% increase in total orders. Intelligent Edge led this backlog increase with a 35% increase, followed by Compute with 20% and HPC & AI with a 15% increase. This surge in orders resulted in the company’s highest ever backlog in the order pipeline. I believe that if the company can fulfill these orders in the third and fourth quarters of 2022, it will post record profits with good profit margins.
Demand for HPE products is cyclical in nature; therefore, I will compare the results on an annual basis. HPE reported Q2 2022 revenue of $6.7 billion, up a negligible 1.5% currency-adjusted. The main reason for this steady revenue growth is the inability to fulfill orders due to supply chain issues in IT hardware procurement. Gross margins were 32.7%, a slight decrease from the previous year, which is attributed to the $126 million incurred out of Russia and Belarus. Diluted EPS was unchanged from the prior year period at $0.19 under GAAP. I think the result was flat and does not warrant order growth being the metric to judge the company’s growth trajectory. According to my analysis, the results have not been impressive, and even the outlook for FY22 is not impressive, with revenue growth estimated at only 3-4%.
Lower revenues and profits of important segments: Storage and Financial Services were both down 2% from Q2 2022. They represent 28% of HPE’s total revenue, and a decline in these segments is not a positive. The Compute segment, which accounts for 44% of HPE’s total revenue, saw only a 1% increase. This means that almost 72% of the total revenue-generating segments showed no growth despite a strong backlog. The reason for the decline in growth is supply chain issues faced by HPE, which they expect will continue through the remainder of FY22.
Profit margins were also down from a year ago. According to my analysis, the trend is likely to continue in FY22 with the Covid-19 restrictions in China adding to HPE’s problems. Additionally, the loss of the HPC & AI segment is cause for concern.
Quantitative ratings and evaluation
My thesis is part of Quantitative assessments to a large extent. I agree that the company is undervalued in terms of valuation, but the growth factor is the real cause for concern with the D- rating. Profitability has also deteriorated from A to A- over the past three months. Overall, the company needs to fix a few issues before I can consider it an opportunity for growth. HPE is currently trading at $13.92, down 13.79% year-to-date. The company has a market capitalization of $18.1 billion. HPE has corrected in line with market expectations and is trading at fair value with a PE multiple of 5x. Compared to its competitors, HPE is trading at a discount, but the supply chain issue is limiting its growth.
My final thought on HPE is that it’s important for them to fulfill backlogs while addressing the supply chain issue limiting its growth. For now, the company seems fairly valued and could be a long-term growth prospect if it delivers on its promise. But the subdued outlook doesn’t compel me to take a position on the stock at this time. After analyzing all of the company’s growth and risk factors and considering its current valuation, I give HPE a holding rating.