After historically taking a siloed approach to managing the business, Hewlett Packard Enterprise Co. (NYSE: HPE) is working to integrate its research and development (R&D) and go-to-market efforts across product areas and business units. Considering its leading presence in each major information technology (IT) hardware segment and IT services, one key analyst believes that HPE has a unique opportunity to emerge as a leading IT provider.
Oppenheimer initiated coverage of HPE with an Outperform rating and a $21 price target. This price target implies an upside of roughly 22% from the current price level.
Overall this bullish thesis is centered on a few things:
- Ability to integrate go-to-market and R&D efforts within Enterprise Group and leverage cross-divisional opportunities (Services and Software) to drive incremental growth
- Renewed commitment to product innovation and a strong and refreshed product portfolio
- Efforts to restructure, reduce cost and improve margins mainly within Enterprise Services
- A high mix of recurring revenue (about 42% of revenue) and strong free cash flow (FCF) that should become more transparent to investors once restructuring payments are paid out
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HPE has reinvested in R&D to drive innovation and refresh its stale product portfolio. R&D expenses increased 19.5%, or 9.3% as a compound average growth rate, since fiscal 2013. This represented 4.5% of revenue in fiscal 2015 versus 3.4% in fiscal 2013. The increased investment is already showing up in the Enterprise Group’s portfolio with upgraded servers, traction in All-Flash arrays and most recently the addition of hyperconverged solutions.
The company’s efforts to improve operating margin offer significant upside potential. Targeting Enterprise Services margin of 7% to 9% by fiscal 2018, HPE is reducing headcount (25,000 to 30,000 employees), consolidating service centers and shifting headcount to lower-cost locations. Illustrating the potential upside, Oppenheimer estimates that for each percentage point there is in Enterprise Services margin, there is an increase of $0.08 in incremental earnings per share.
Oppenheimer detailed in its report:
Our positive view is focused on HPE’s strong recurring revenue/FCF generation. Once restructuring payments cease after FY18, FCF could exceed $4B/year. We expect over 50% return to shareholders (down from 100% FY16 target). We estimate about 42% of revenue and about 52% of operating profit come from recurring sources. We view this as a strong indicator of FCF stability.
Shares of HPE were trading down 1.8% to $16.95 Friday morning, with a consensus analyst price target of $17.35 and a 52-week trading range of $11.63 to $18.55.
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