Why is Hewlett Packard Enterprise's (HPE) stock down more than 10% after the company beat estimates and hiked its full-year EPS guidance? Concerns about an expected second-half slowdown in revenue growth rates appear to be a culprit, as does the fact that HPE's latest results don't look quite as impressive after accounting for some short-term events and cash-flow pressures.
The larger issue, however, might be how HPE's expected growth slowdown reinforces existing worries about the company's ability to deliver meaningful organic revenue and cash-flow growth over the long term.
Results and Guidance
HPE reported April quarter (fiscal second quarter) revenue of $7.47 billion (up 10% annually) and non-GAAP EPS of $0.34, topping consensus analyst estimates of $7.39 billion and $0.31, respectively. The company also guided for July-quarter EPS of $0.35 to $0.39, favorable at the midpoint to a $0.36 consensus. And it hiked its fiscal 2018 (ends in October) EPS guidance by $0.05 to a range of $1.40 to $1.50.
But on the earnings call, CEO Antonio Neri said HPE sees "a more challenging second half" to fiscal 2018, and predicted revenue growth rates would slow due to tougher annual comps, a smaller currency boost and the passing of the 1-year anniversary of acquisitions.
Short-Term Sales and Earnings Boosts
As Neri's remarks indicated, a weak dollar has been lifting HPE's top and bottom lines: Last quarter, revenue growth was 10% in dollars but only 6% in constant currency (CC). With the dollar having recently begun to strengthen, forex is set to be less of a tailwind for HPE and other U.S. multinationals during the back half of the year.
April-quarter sales also benefited from a healthy IT spending environment, an ongoing Intel (INTC) server CPU upgrade cycle -- along with forex, it helped HPE's Compute (server) revenue rise 6% to $3.21 billion -- and the company's $1 billion April 2017 acquisition of mid-range storage vendor Nimble Storage. Storage revenue rose 24% overall to $912 million, but only by 14% organically. Neri does say, though, that HPE expects to continue seeing "solid organic growth" in storage.
After backing out both M&A and forex, HPE suggests its April-quarter revenue growth was around 4.5%. Earnings, meanwhile, got a lift last quarter from a lower-than-expected 9.6% tax rate, as well as from cost cuts (non-GAAP operating expenses only rose 2% annually) and $917 million worth of stock buybacks. Moreover, HPE is now guiding for its fiscal 2018 tax rate to be at the low end of a prior guidance range of 11% to 15%.
Cash Flow Issues
HPE's free cash flow (FCF) was a weaker-than-expected negative $269 million last quarter. On the call, the company partly blamed elevated inventories and payables, which in turn were blamed on the "strategic positioning of key commodities and somewhat higher pricing."
The company is still reiterating its fiscal 2018 FCF guidance of "approximately $1 billion." However, HPE added that its cash flow will get a boost from new real-estate sales. And some analysts aren't sure the company will hit its guidance. Earnings quality, long a concern for fellow IT giant IBM (IBM) is starting to become a worry for HPE as well.
Long-Term Hardware Pressures
At its October 2017 analyst day, HPE outlined a long-term financial model that called for organic revenue growth of just 0% to 1%. And though HPE's organic growth has been better than that the last couple of quarters with the help of the aforementioned factors, there are still plenty of reasons to think that this long-term model will be close to the mark.
Like some other IT giants, HPE's biggest hardware problem has been the reluctance of cloud giants such as Google (GOOGL) , Facebook (FB) , Amazon (AMZN) and Alibaba (BABA) to buy its data-center gear in large quantities, in part due to their fondness for white-label hardware based on internal and open-source designs. And with HPE having officially given up on its efforts to supply commodity servers to cloud giants last fall, this situation seems unlikely to change.
HPE's limited cloud exposure is a problem both because cloud giants are aggressively upping their capital spending, and because the percentage of enterprise server workloads running on public clouds is rapidly growing. Intel has forecast its enterprise data center sales will decline over the long-term (cloud sales are a very different story), and there's little to reason to think the same won't hold for sales of enterprise servers that have traditionally relied on Intel's silicon.
The Big Picture
HPE has done a decent job of using acquisitions and internal R&D to strengthen its enterprise hardware position. In addition to the Nimble deal, the company's purchases of hyperconverged infrastructure vendor SimpliVity and enterprise/carrier Wi-Fi vendor Aruba Networks have put it on better footing. So have investments in new server platforms and storage software.
But in the end, all of this is only serving to make HPE a slightly larger fish in a steadily shrinking pond. With the company's fate largely tied to enterprise hardware following 2016 deals to unload most of its software and services assets, and with earnings quality now more of a concern, the low earnings multiples HPE trades at look pretty understandable.