Can Earnings Narrow The Value Gap In Hewlett Packard?

As the chip and semiconductor industry seems to have found new grounds for revolution, as seen in NVIDIA NASDAQ: NVDA sporting its new record one trillion-dollar market cap, other names in the space are looking to ride on this renewed sentiment toward the next frontier in technological advancements. Companies like Taiwan Semiconductor Manufacturing NYSE: TSM have rallied by as much as 26% during the past quarter as it stands to be the backbone of the new chip revolution operating in the artificial intelligence space. In the after-market hours of Tuesday evening, a low-flying name in the sector reported its second-quarter 2023 earnings.

Hewlett Packard Enterprise NYSE: HPE shares are trading lower by 6.6% as some investors digest the final results in the company's press release. The company reports near-record results as far as revenue goes. However, it is still experiencing some of the setbacks that other operators in the value chain are suffering from. For example, Apple NASDAQ: AAPL reported that its computer shipments declined by 40%, as noted within its Mac shipments. However, Hewlett Packard's portfolio has offset these headwinds by posting high double-digit advances in the new opportunities that generative artificial intelligence poses for the business. 

Shifting Winds

Despite its largest segment, compute, Hewlett Packard reported 9% revenue growth posing a 3% decline in the twelve months covered. The second-largest segment, Intelligent Edge, posted a 56% advance in total sales to finish the quarter at $1.3 billion. These two segments, and their underlying relationships, can give investors a more straightforward path into what management is keeping in store for the future of the business. Intelligent Edge, essentially the computing power side of things allowing for generative A.I. projects to come alive, has been quietly advancing in total revenue share and keeping a more attractive operating margin. Hewlett Packard's Compute segment carries a 15.2% operating margin, while Intelligent Edge accrues a 26.9% operating margin to its share of profits. 

What is more important for investors is the underlying pivots and advances within the two businesses. As Compute's operating margins only increased by 1.1% coupled with a 3% revenue decline, Intelligent Edge posted a 14.3% operating margin expansion over the twelve months, alongside its 56% revenue increase. The marketplace has voted on what the next wave of demand will be made of by assigning companies like NVIDIA a 203.3x price-to-earnings ratio, while Hewlett-Packard carries only a 23.7x multiple. It would be airy to believe that HPE will command a significantly higher multiple to match that of NVIDIA; however, considering that the company has shown its intentions to move into the field and taking the proper steps at that, investors could soon wake up to the realization that the stock is severely underrated. 

Setting Expectations

The results seen in the new product mix enabled the company to finish the quarter with a favorable free cash flow position, which management rightly allocated to reward investors. Those who stuck by the company's challenging times to transform, and take on the new phase of its Intelligent Edge business, received the pleasant news of a $261 million capital return via dividends and buybacks during the second quarter of 2023. By shifting to higher-growth products with improved performance, the business has achieved a record gross margin of 36%, which is also expected to continue. Now that the company is presenting nothing but improvements and growth, why would the stock sell off the way it did after the announcement? Management's guidance for the year may hold the answer. 

Executives point to a relatively conservative revenue growth rate of 4-6% for the remainder of the 2023 fiscal year, with a significant discrepancy between GAAP and non-GAAP operating profit expectations. Hewlett Packard's financials will show that the income statement contains some rare items, which may drive the confusion expressed by the stock price's swing. "Transformation costs" and "Disaster charges" added to $63 million in the second quarter of 2023 and are driving an even larger wedge in the end-of-year outlooks. Management expects GAAP operating profit growth to be 180-184%, while GAAP operating profit growth is only 6-7%, driven by these non-operating charges. Following the more natural state of earnings, investors could expect to see earnings per share within the $2.06 and $2.14 range.

Hewlett Packard analyst ratings suggest that the stock only has an 8.5% upside potential, excluding the effects of the after-market sell-off. However, these ratings may only reflect the previous quarter's Intelligent Edge results, where the segment only represented 14% of total revenue compared to today's 18%. Considering this growth, coupled with the fast advancement of its operating margins, analysts may soon have to push the top-side price target of $20 as a median consensus.