Should You Add Hewlett Packard Enterprise Co (NYSE:HPE) To Your Portfolio?

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Hewlett Packard Enterprise Co (NYSE:HPE) impressed in its first financial report as an independent company. Both EPS and revenue in F1Q2016 surpassed expectations and the management also guided strongly for fiscal 2016.

After splitting from HP Inc. (NYSE:HPQ), HPE is less burdened by the slow computer and printer businesses. Additionally, the company has embarked on aggressive cost-reduction and product portfolio refresh. But, can HPE continue impressing in the coming years? This HPE analysis article examines the company’s risks and opportunities to bring out what you need to know about this leading enterprise IT vendor. But first, here is a quick recap of the last quarter’s earnings.

F1Q2016 highlight

Hewlett Packard Enterprise Co (NYSE:HPE) posted EPS of $0.41 on revenue of $12.72 billion. Both the EPS and revenue smashed the consensus estimates that called for $0.40 and $12.68 billion respectively.

The chart below shows HPE’s revenue and cost of revenue for the last five quarters:

hp

Fiscal 2016 outlook

For fiscal 2016, HPE is targeting EPS in the band of $1.85 to $1.95, against the consensus estimate of $1.87.

What’s exciting about HPE?

  1. Cost-cutting initiatives

Hewlett Packard Enterprise Co (NYSE:HPE) is in the process of cutting weight. Simplifying the corporate structure and retrenching staff are some of the measures the company is taking to cut cost. HPE wants to cut between 25,000 and 30,000 jobs from its system, which will result in about 12% headcount reduction. The layoffs will enable HPE to reduce its payroll burden and save funds.

HPE is also moving more of its employees abroad to lower-cost regions. At the end of fiscal 2015, 45% of HPE’s workers were located offshore and it is targeting to put 60% of its headcount in low-cost offshore locations within the next two years.

All these measures are aimed at trimming operating costs and saving more money that can be invested in more growth or returned to shareholders. The management has committed to return 100% of free cash flow to shareholders.

      2.Financial stability

Although HPE is already generating steady and recurring free cash flow, the amount is still compressed due to breakup related payments that total $1.6 billion in fiscal 2016 and the ongoing restructuring measures. In the near future, HPE will put these pressures behind it so that it can generate strong free cash flow. HPE finished F1Q2016 with more than $8.5 billion in cash and equivalents.

It is also important to note that a significant portion of HPE’s revenue also comes from recurring sources, which offer protection to the company’s financial position in the event of unexpected macroeconomic headwinds.

     3.R&D coordination

Since breaking away from the parent HPQ, Hewlett Packard Enterprise Co (NYSE:HPE) has been working to simplifying its operating structure by specifically dismantling structures that complicated its operations and inhibited R&D coordination. Among other things, HPE has been more focused on bringing product groups closer together, thus encouraging better R&D cooperation and coordination. These measures should enable the company to use its R&D budget more efficiently and increase time to market for new innovative products.

      4.Product portfolio shakeup

HPE is in the process of renewing its product portfolio to make in more competitive. As such, the company is refreshing existing products and at the same time rolling out new ones. Partly, that is being achieved through increased spending on R&D. In fiscal 2016, HPE’s R&D budget is expected to go up relative to fiscal 2015 level. R&D spending was 4.5% of total revenue in fiscal 2015 compared to 3.4% in fiscal 2013.

What’s worrying about HPE?

  1. Restructuring costs

For the 2015 restructuring, Hewlett Packard Enterprise Co (NYSE:HPE) plans to complete the payments related to it by the end of 2018. However, completing the restructuring plan and obtaining the desired outcome are two different things. As such, if HPE’s post-breakup reorganization drags, it might be difficult for the company to reach its revenue, profitability and free cash flow targets.

      2.Cannibalization of traditional IT market

Enterprises are shifting from on-premise infrastructure to cloud platforms. But the shifting of enterprise workloads to the cloud threatens HPE’s traditional IT infrastructure business. Cloud is increasingly grabbing a larger share of enterprise IT infrastructure spending, thus limiting revenue opportunities in the legacy IT infrastructure market.

As spending in traditional IT systems shrinks, competition has also heightened in the space, thus threatening HPE’s revenue growth. Unless the company finds a way to tap into the cloud movement, future growth could be compromised.

     3.Currency headwind

Hewlett Packard Enterprise Co (NYSE:HPE)’s massive exposure to the global markets is both an opportunity and a risk. It is an opportunity when demand for its products and solutions is strong on the global market and foreign exchange rates are favorable. But when the U.S. dollar appreciates against major global currencies, there is a problem. HPE’s products not only become more expensive on the global market thus less competitive, but international sales also turn up doused when converted to U.S. dollars.

    4.Exposure to interest rates

The Fed is expected to perform two interest rates increases this year. But rate increases could adversely impact HPE in a number of ways. For example, higher rates could affect HPE financing rates, thereby affecting sales, and profitability. In another way, rate increases could increase HPE’s interest expenses considering that the company has debts that mature in 2017 and 2018. Therefore, when interest rates go up, it means that borrowing to refinance existing debts would become more expensive for HPE.

     5.Stiff competition

Enterprise IT vendor space is highly competition. Hewlett Packard Enterprise Co (NYSE:HPE) faces competition from both established vendors such as International Business Machines Corp. (NYSE:IBM) and Cisco Systems, Inc. (NASDAQ:CSCO) and from startup vendors that are pulling customers away with competitively priced solutions.

Surviving the competition that is coming from above and below will depend on HPE’s ability innovate faster and adapt quickly with the changes in its industry.

      6.Execution risk

The management of HPE is under pressure to prove that the company can do better as an independent entity. But the pressure to impress Wall Street could lead to hurried executions that do not result in any thing meaningful at the end of the day.

Takeaway

The initial financial report by Hewlett Packard Enterprise Co (NYSE:HPE) as an independent company was impressive. The guidance for fiscal 2016 is also encouraging. The management insists that HPE’s better days are ahead. There are low-hanging fruits that HPE will be able to pick on its way to total transformation, but there seems to be little room, if any, for execution error. That explain why investors should closely what the stock.

Disclaimer: The opinions and data expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisory capacity, nor is this an investment research report. The author’s opinions expressed herein address only select aspects of potential investment in securities of the company or companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.

Neha Gupta

Neha Gupta has been in the financial space for over six years now. Gupta earned her MBA degree from Symbiosis Centre of Distance Learning in 2009 and her passion for finance led her to pursue Chartered Financial Analyst (CFA) course. She has successfully completed Level II of her CFA. She is a veteran in article writing, which is depicted in her numerous pieces published on SeekingAlpha, Nextiphonenews, InsiderMonkey, MarketWatch, and Techinsider. Her crisp and eloquent writing finds its best place in Researchcows, where emphasis is given on developing rich content for various websites, products, business plans, trainings, and book writing.

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