Hewlett-Packard Enterprise Is Currently Very Undervalued. (NYSE:HPE)

Investing these days is anything but simple. Most people will agree that the market will recover at some point, but when and to what extent no one can truly answer right now. In my mind, if one is going long, there two things to consider, and they can be conflicting if one is not careful. The first is, how will it navigate the current pandemic, not only in terms of current sales, but if it will be harmed by structural changes that last long after the pandemic has ended. The other is our normal criteria when we buy a stock; assuming the pandemic did not exist, would we still find it attractive. The latter will gain significance as things subside, and for anyone going long, may be the worthier argument.

There are a few stocks I really like at this time, although I would never try to guess when they will recover, because I am not sure anyone knows that right now. I’m actually pretty sure no one does. Hewlett-Packard Enterprise(HPE) is one such stock, and is the subject of this article.

We will start with the fundamentals of the company, while also looking into short-terms problems and opportunities offered by COVID-19.

One of the complaints about the company is it has not seen revenue growth, and in fact has seen some degree of regression. The company has been able to increase earnings per share, however, but this is largely due to stock repurchasing. If we look at the first quarter, it’s instructive to realize that although revenue was down 7% year-to-year, if we look closer, we see a lot of positive trends.

First, the revenue loss was largely in their Compute segment, which saw a 15% reduction in revenue. However, there are two major reasons for this, the first being the COVID-19 impacted their component supplies, and the other was a pivot to as-a-service, which reduces current revenue for a more sustained model. It is also worth noting that the company ended Q1 with a large backlog of orders, due to component supply problems.

Recurring revenue is a bright spot for the company, and was up 19% year-to-year. Currently, recurring revenue is roughly 1/3 of the revenue for the company, but 75% of the profit, so clearly represents an important avenue to focus on.

While revenue is nice, profit is what makes it worthwhile. The company was able to increase gross margin by 210 points, to 33.2%. In fact, for the last two years both margins and EPS has grown every quarter.

As the company focuses more on hybrid cloud/server implementation, and recurring revenue, I would expect revenue growth to remain difficult in the near term, but margins to continue to increase. Also, this type of differentiation offers very real advantages over pure cloud providers in certain scenarios.

Oddly, HPE was pummeled, like almost all the market, by the COVID-19 panic. In reality, the company has indicated in the previously given links, that it is much less exposed to the consequences of it than the broader market, but it seems this went unnoticed. In fact, HPE has repeatedly stated it has limited exposure to the more COVID-19 sensitive segments. Currently, 85% of HPE sales go to large companies or the public sector, while only 15 per cent to small businesses. HPE also has limited exposure to those segments, such as hospitality, travel and energy, that have suffered the most from COVID-19.

HPE is seeing a very high need for extending the working network to other locations securely, primarily homes. HPE’s Aruba mobility controller allows a user to power on their machine remotely, and have it access applications as if they were in the workplace. HPE configures the internet router before it is shipped, so requires no configuration by the end user, or IT support. It also allows remote monitoring. This is very simple, with no need for a VPN, so has seen a huge surge in demand. Of course, VPN solutions are available too, using Aruba Central, but this does not differentiate them from other vendors.

This is an example of where COVID-19 catalyzes a change that could become permanent. As businesses weigh the effects of working remotely, or extending their network, they may find it beneficial to make some changes permanent. Also, an employee that has remote access that works almost exactly as their office, and has technology intelligent enough to know how to prioritize their ISP’s bandwidth, is not going to want to go back to what they had before. And the IT department may prefer such an easy solution, as it saves support costs.

Lastly, if one looks at the earnings, and financial stability of the company, one can not help but wonder how the company is selling so low. With a strong business model, improvement in margins and EPS, and limited exposure to COVID-19, the value of this company far exceeds the $9.30 it is selling at, as I write this. Although revenue improvement remains a concern, particularly with COVID-19, the move to recurring revenue and the enormous growth the company is seeing there, gives me confidence the company will continue to remain very profitable not only as it navigates through the current macro-economic situation, but after the dust settles and business returns to normal. Or the new normal, which probably will benefit this company.

Disclosure: I am/we are long HPE. 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.

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