The Tech sector has enjoyed the lion’s share of attention among all segments of the economy for a number of years. That’s been a good thing during bull markets, but it also means the sector really gets pummeled when uncertainty increases.
Since 2020, that attention – driven in no small part by the increasingly central role of cloud-based and remote networking solution providers in facilitating remote workforce solutions – motivated investors to buy Tech stocks enthusiastically. The flip side of that attention has reared its ugly head this year, as higher interest rates, war in Ukraine, and continued supply chain constraints that started with technology have rippled into multiple segments of the economy. A lot of Tech companies have seen their stock prices plunge this year into their own bear market levels. Again, Tech is leading the way in the stock market, as the entire market has persisted in bear market conditions for most of the year, with multiple failed rallies to keep the bearish tone in place.
Since early 2020, companies that focus on the “enterprise” space – where most corporate tech spending has traditionally gone, for products like servers, computers, printers, and the tools to connect them all in a traditional network setting, for example – have struggled to keep up with demand for remote workforce solutions and cloud-based services. While I think that much of the work-from-home element of corporate operations will become a permanent part of business life, there are also signs that for many businesses, back-in-office is becoming an increasing expectation. My research into many of these companies suggests that while many of the companies that operate in the Enterprise space will continue to be pressured for the time being, revenues and earnings in many cases have also begun their own recovery. Current geopolitical, economic and market conditions haven’t entirely been reflected in some of those metrics as of yet, which implies that how elements play into the fortunes of companies in the Tech sector for the rest of this year is a risk element that could act as a longer-term headwind to economic health and growth.
That brings us to today’s highlight. Hewlett Packard Enterprise Co. (HPE) is a spin off of Hewlett Packard Corporation (HPQ), and a business that is among those companies that underperformed through most of 2020 but saw strength beginning in September of last year, rising from a low at around $13 to a February 2022 peak at nearly $18. From that point, broader market fears pushed the stock into a new downward trend that found its bottom at around $12.50 in July, then staged a strong rally that peak in mid-August at around $15. The stock has followed the rest of the market lower since then as the Fed has reiterated its intention to keep raising rates to tame inflation, pushing the stock to its most recent low at around $13 last week. This is a company that has seen some material improvements in its fundamental strength and its value proposition since the end of 2021. Have those improvements held up so far in 2022’s difficult economic environment? If they have, HPE could be a good stock to think about using for a functional, value-based investment right now.
Fundamental and Value Profile
Hewlett Packard Enterprise Company (HPE) is an edge-to-cloud platform-as-a-service company. The Company’s segments include Compute, High Performance Compute & Mission-Critical Systems (HPC & MCS), Storage, Advisory and Professional Services (A & PS), Intelligent Edge, Financial Services (FS), and Corporate Investments. The Compute portfolio offers both general-purpose servers for multi-workload computing and workload-optimized servers. HPC & MCS portfolio offers workload-optimized servers designed to support specific use cases. FS provides investment solutions, such as leasing, financing, information technology (IT) consumption, and utility programs and asset management services, for customers that facilitate technology deployment models and the acquisition of complete IT solutions, including hardware, software and services from HPE and others. Corporate Investments include Hewlett Packard Labs, which is responsible for research and development. HPE has a current market cap of $17 billion.
Earnings and Sales Growth: Over the past year, earnings increased by almost 7%, while sales saw a marginal, 0.78% increase. In the last quarter, earnings we were a little more than 63% higher, while sales also rose by 3.55%. The company operated with a narrow margin profile through 2020 that saw big improvements in 2021, but is showing signs of deterioration in the last quarter; over the last twelve months, Net Income was 13.32% of Revenues, and declined sharply to 5.88% in the last quarter. This is a red flag that bears watching in the quarters ahead.
Free Cash Flow: HPE’s Free Cash Flow is healthy, at $2.07 billion. On a Free Cash Flow Yield basis, that translates to 12.18%. A year ago, Free Cash Flow was $3.7 billion. The decline since that high point adds weight to the warning signal we see from the company’s Net Income pattern, but I should add that this number increased marginally over the last quarter, from exactly $2 billion.
Debt to Equity: HPE has a debt/equity ratio of .44, which is a conservative number. Their balance sheet shows about $3.7 billion in cash (compared to $3 billion a quarter ago) against a little over $9.1 billion in long-term debt. Their operating profits are adequate to service their debt, with health financial flexibility as well, however the latest quarter’s declines in Net Income, if they continue to persist could act as drags on the company’s liquidity. It should be noted that in the first quarter of this year, long-term debt was around $9.1 billion, meaning that the company has eliminated about $2.2 billion of long-term debt from their balance in that period, with about $800 million being retired in the last quarter.
Dividend: HPE pays a dividend of $.48 per share, which translates to an annual yield of about 3.64% at the stock’s current price. I think that it is also noteworthy that the company has not cut or reduced their dividend; in fact it remains a bit above the $.44 per share payout they maintained until the beginning of 2020, when management increased the dividend to its current level.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to worth with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term target at about $18 per share. That suggests that HPE’s stock is undervalued, with about 37% upside from its current price.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The chart above displays the last year of price activity for HPE. The red diagonal line traces the stock’s downward trend from a high point in January at around $18 to its low in July at around $12.50. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. With yesterday’s selloff in the broad market, HPE is testing current support at around $13 right now, with immediate resistance at around $14. If $13 doesn’t hold, there should limited downside to about $12.50, however if bearish momentum really accelerates the stock could fall to about $11.50, based on the distance between a break below support in late June to the stock’s July low point. A push above $14 should find next resistance at around $15 per share.
Near-term Keys: HPE has been following the rest of the Tech sector lower over the last couple of months. The stock’s recent drop suggest that betting on continued downside could be low-probability, low-reward bet, with the stock already close to its 52-week low, and relatively limited downside if that low doesn’t hold. That makes betting on a bearish trade, either by shorting the stock or buying put options is a very speculative trade. A bounce off of current support could be a bullish trading opportunity to think about buying the stock or working with call options, with $15 acting as a good profit target. The stock’s value proposition, in the meantime, is very attractive, and even compelling. I do see the last quarter’s decline in Net Income as a red flag that has extended over the past two quarters, and deserves attention in the event current difficulties persist. Those issues could also be somewhat cyclical concerns, driven by sector-wide supply disruptions. If you’re willing to be patient, the stock offers an interesting value-based opportunity, however in the near-term the stock could continue to see high levels of volatility.