HPE Earnings: Networking Shines and Margin Strength Offsets Weak Server Demand; Maintain $16 FVE

We maintain our $16 per share fair value estimate for Hewlett Packard Enterprise HPE after it reported mixed, but solid fiscal second-quarter results. HPE’s sales missed our expectations and it lowered its full fiscal year sales guidance, but earnings met our expectations and it raised its bottom line guide for the full year. The firm’s networking business continues to buoy results throughout the income statement, while the server and storage businesses are acting as anchors on growth. We think an 8% drop afterhours is an overreaction to demand headwinds, particularly in servers, that we see as transient and cyclical. Nevertheless, we would recommend investors wait for a greater margin of safety to buy shares of no-moat HPE.

Fiscal second-quarter sales rose 4% year over year, but dipped 11% sequentially to $6.97 billion. The edge (networking) and supercomputer segments continue to grow rapidly, and 50% year-over-year growth for edge sales was particularly impressive. In our view, three straight quarters of double-digit year-over-year growth for edge implies market share wins for HPE, likely in wireless and wide-area networking. Conversely, the compute (servers) and storage businesses continue to flail, both declining single digits sequentially and double digits year over year. Both businesses are experiencing a downturn in demand with customers digesting orders already received, which represents the cyclical and commoditylike nature of these products in our view.

Terrific margins offset the impact of lower sales on the bottom line. Non-GAAP gross margin of 36.2% was up 150 basis points year over year, and non-GAAP operating margin of 11.5% is a very healthy level for HPE. Server pricing discipline and networking strength helped HPE’s profitability.

Guidance for the fiscal third-quarter implies flat sales and expanding margins. We anticipate trends to continue, but for weakness to plateau in servers and storage.