Hewlett Packard Enterprises: Too Mixed To Be Attractive

Summary

• HPE's as-a-service segment is immaterial today, and likely to remain inconsequential until 2022.
• Even though share buybacks are suspend, its 5% dividend is here to stay.
• Valuation is undoubtedly attractive. But whether it can turn around or not is a different matter. Thus, I'm staying on the sidelines and watching.
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Investment Thesis

Hewlett Packard Enterprises (NYSE:HPE) has fallen from grace. And although its valuation is undoubtedly attractive, its underlying prospects are not alluring enough to make this investment one worth chasing today.

On the one hand, its balance sheet is not as strong as it first appears. Furthermore, although its 5% dividend yield is high, I do not believe it compensates investors enough to buy the equity simply on the premise of getting this high yield.

In summary, the time to get involved with HPE has not arrived yet.

Cheap Can Always Get Cheaper

Hewlett has taken an aggressive beating, no doubt. What's more, shareholders don't like to hear this, but cheap can always get cheaper. In other words, just because it has fallen meaningfully does not in and of itself point to a strong bargain opportunity. Ultimately, the stock is worth whatever its worth, irrespective of what it traded for last year.

I'll try to point to the positives and negatives, and how they line up for the shareholder.

For me, the biggest aspect which I have to square up with is that Hewlett's balance sheet is not so strong. Even though management points towards it having approximately $10 billion in liquidity, the bulk of this liquidity is undrawn credit capacity.

Source: Q2 2020 Investors Presentation

Accordingly, if we put aside its financing arm, you are left with a company that has a net debt position -- although, admittedly, not meaningfully leveraged. Nonethless, even if one makes the argument that there's flexibility to draw down credit to do something more agressively, such as share repurchases, I would question this strategy.

Share Repurchases Suspended, What About Dividends?

Objectively, I'm looking in hindsight, which makes my assertions not only unremarkable but unfair, too. Thus far, after deploying approximately $4.5 billion towards share repurchases these past two years, its shares nevertheless trade at a multi-year low.

For now, investors will have to contend themselves with the 5% dividend yield, which is way above the market average. Thereby forcing the unsavory, yet necessary, question of whether Hewlett has the capital to keep this premium dividend.

Assuming that Hewlett's dividend cost the company in the ballpark of $620 million, for now, Hewlett has enough capital on its balance sheet together with its free cash flow potential to support this dividend. In other words, I would reason that its dividend is here to stay.

As-a-Service Business, Does It Matter?

HPE GreenLake business is up 17% year-over-year and has an ARR of $520 million. Consequently, it could be said that out of close to $29 billion in revenues (2019 sales figure), it has approximately half a billion that is recurring. Thus, I'll repeat, does this matter? Is this half a billion revenue source enough to get excited over this investment?

Even at the top-end of its guided 40% CAGR target, this would imply that by the end of 2022, this business unit would be generating close to $1.4 billion in recurring revenue. In my skeptical view, not only would that involve a huge ramp up from the sequential decline from Q1 2020 when this unit was growing at 19%, before falling to 17% this quarter, but in fact, 2022 is still quite some time away for what could be less than 5% of its revenues in three years' time.

What About The High Gross Margins?

The graph below does a good job of summarising what's at play here:

Source: Investor Presentation -- Q1 2018 through to Q2 2020

During 2019, whilst the economy was strong, HPE's non-GAAP operating margins were approximately 9%, with Q4 2019 reaching peak profitability of 10.2%.

Valuation - The Bullish Thesis Starts Here

I'm a value investor. And when I first approached HPE, I considered whether it was worth investing in. I tried to see if I could find enough upside potential. And given that before its guidance was withdrawn, HPE's full-year 2020 GAAP guidance was pointed towards the midpoint of $1.08, this puts its stock trading for less than 10x its current year's EPS GAAP figures. There's simply no way anyone could make the argument that this stock is overvalued.

Thus, here's my quandary. While I can't see its potential to turn around and ramp-up operations in any significant way, there aren't many companies generating close to $29 billion in sales being priced at less than 10 times prospective earnings.

The Bottom Line

This is a mixed bag investment opportunity. The company continues to be hit by hard times, and its prospects are not incredibly alluring. On the other hand, it could be said that a large portion of this negativity has already been priced in.

On balance, I believe this is an opportunity well worth following.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[metoo5]

HP has been a rudderless company for a couple of decades. Their best idea in the last 20 years was to put 1/2 the normal amount of toner in the laser printer cartridges that ship with printers so printer buyers would have to buy new (high margin) toner cartridges more quickly after buying a printer than normal.

[Michael Wiggins De Oliveira]

Not quite the same company. That's HP. This is HPE. Two very different companies.

[metoo5]

Yes, one rudderless company became two.

[DownTheDrain]

Thanks for a timely assessment on HPE. I agree that now is not the time. I'd like to see HPE become a presence in it's field, so I have an initial limit order for HPE at $8.25. With potential skin-in-the-game, I'll pay more attention to it. The low entry point is dictated by my "iPhilosopher" Mr. Chit (full Chinese name: Ho Lee Chit)

[Michael Wiggins De Oliveira]

@DownTheDrain
That's witty ;) Thanks for the comment. ;)