Investors have a short-term memory, so when Hewlett Packard Enterprise (HPE) earned a pair of upgrades, the stock’s rally should catch the DIY value seeker’s attention. I thought an ideal entry point on HPE stock in the $12-13 range would adequately discount the forward macro risks ahead. But the double upgrade puts the stock in the profit-taking space, even though a $19 price target suggests another $3 in upside ahead. What are the pros and cons of buying HPE stock at these levels?
Strong Data points from Third Quarter
HPE reported gross margins of 33.9%, up 170 basis points sequentially and 340 basis points from last year. It benefited from a shift to higher-value offerings and commodities pricing tailwinds. The $860 million in free cash flow YTD and operating profit margin of 9.9% sent HP Enterprise stock from around $13 to $16.30 recently. The ongoing trade tension saga is now easing as the US and China agree not to implement additional tariffs. And shareholders are not so worried about the HPE’s elongated sales cycle delaying a recognition in revenue each quarter.
Customers will still need to accelerate their digital transformations to improve their business. This rationale would also apply to DXC Technology Company (DXC). But unlike HPE, DXC lowered its guidance, sending the stock to all-time lows. Still, HPE lost arbitration and had to pay $666 million to DXC. Still, HPE has plenty of growth drivers ahead.
Intelligent Edge revenue grew 14% sequentially to $762 million and down 2% from last year. It made adjustments to its sales model in the U.S., which should drive sales. Its Aruba services business performed well in EMEA and APJ. Customers chose Aruba’s mobile-first network with ArubaOS 8. The product gives secure mobility and lets customers upgrade networks live, without any downtime.
Aruba Central is another potential winner. The company added enhancements to the cloud-based platform that manages over 20,000 customer branch networks. The upgraded version has AI, better security, and is easier to use. And even more exciting is HPE’s Hybrid IT, whose operating margins are at levels not seen since Q1/2017. At 12.7%, the operating margin rose 260 basis points year-on-year. Despite a tougher macroeconomic environment, HP Nimble Storage grew 21% and Hyperconverged grew 4%.
The acquisition of Cray will close at the end of Q4. Having closed the deal earlier than expected, expect the supercomputing unit to add positively to revenues. It also helps that Cray won a $600 million contract for the National Nuclear Security Administration (‘NNSA’) and Lawrence Livermore National Laboratory (‘LLNL’). HPCwire noted:
the joint DOE-NNSA effort to procure up to two CORAL-2 awards for the exascale supercomputers with a potential budget of $1.8 billion.
Trade tensions led to an uneven demand environment in the third quarter. Elongated sales cycles also added to the difficulty in forecasting the expected quarterly results. But the new offerings currently and ahead will drive sales, especially in the SMB market. Investors just need to wait for the stock to fall before accumulating it. And when the market sentiment changes, just as it did after the Bank of America upgrade, it gives investors a chance to sell at a profit or to enjoy the paper gains.
Valuation and Your Takeaway
HPE management continues to increase shareholder returns. At the end of Q3, it returned $2.4 billion to shareholders through $500 million worth of dividends and $1.9 billion in share buybacks. Even though at about $16 a share, the stock trades slightly above the analyst average target price (per Tipranks), investors should hold HPE stock. The company is guiding a stronger free cash flow in the fourth quarter of $1.4-1.6 billion (non-GAAP). As it deploys that cash back into the business, its customer orders will increase thanks to continued updates to its core offerings.
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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.