HPE's Critical Moves In AI And Cloud Forecast A Bright Revenue Future

Key Takeaways

• Accelerated innovation in AI and hybrid cloud technologies is anticipated to significantly boost revenue as demand for advanced AI applications grows.
  
• Strategic acquisition of Juniper Networks and growing Annual Recurring Revenue signify a shift towards high-margin businesses and stable revenue streams.
  
• Dependency on large, unpredictable AI system deals and aggressive shifts towards services and cloud-native solutions may cause volatile earnings and pressure margins.

Catalysts

Provides solutions that allow customers to capture, analyze, and act upon data seamlessly in the Americas, Europe, the Middle East, Africa, the Asia Pacific, and Japan.

• Accelerated innovation in AI and hybrid cloud technologies, which is expected to drive significant revenue growth as enterprises seek advanced AI and cloud solutions to stay competitive. This innovation in technology particularly impacts revenue by catering to new and emerging market demands for AI applications and hybrid cloud environments.
  
• Expansion in specialized AI system sales with a notable increase in AI system revenue conversion, suggesting a growing demand that could positively influence future revenue growth, especially in server and AI systems segments where HPE has shown a strong performance.
  
• The strategic acquisition of Juniper Networks to enhance HPE's networking capabilities, aiming to accelerate its edge-to-cloud vision. This acquisition is expected to improve gross margins and non-GAAP EPS in the year post-close, directly impacting earnings through the integration of high-margin business.
  
• Growing Annual Recurring Revenue (ARR) through the HPE GreenLake Cloud platform, signifying a shift towards consumption-based and subscription models, which could lead to more predictable and stable revenue streams, positively affecting net margins over time due to potentially higher-margin software and services mix.
  
• Strong performance in the Intelligent Edge and Hybrid Cloud segments, with investments in AI-driven networking and cloud-native, software-defined solutions that cater to rising enterprise demands. This focus is likely to contribute to increased profitability and revenue, especially with the positive trajectory of orders and returns from ongoing investments in product portfolio and specialized sales.

Assumptions

• Analysts are assuming Hewlett Packard Enterprise's revenue will grow by 5.9% annually over the next 3 years.
• Analysts are assuming Hewlett Packard Enterprise's profit margins will remain the same at 6.4% over the next 3 years.
• Analysts expect earnings to reach $2.2 billion (and earnings per share of $1.69) by about November 2027, up from $1.9 billion today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $3.4 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 16.9x on those 2027 earnings, up from 15.1x today. This future PE is lower than the current PE for the US Tech industry at 23.1x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.42%, as per the Simply Wall St company report.

Risks

• The dependency on large AI system deals which are characterized as lumpy could result in volatile revenue and earnings due to the irregular timing and size of these deals.
  
• The mix of AI server sales, which currently includes a significant portion of lower-margin systems (30% of server revenue this quarter from AI systems), might continue to pressure gross margins in the server segment.
  
• The aggressive shift towards offering more services as part of AI system sales, while potentially beneficial for long-term revenue streams, initially leads to deferred revenue recognition, which could impact short-term profitability and cash flow.
  
• The cost pressures from rising commodity costs, especially in the SSDs, as noted in the Hybrid Cloud segment, could erode margins if not offset by price adjustments or cost improvements.
  
• The vast investment in transitioning to cloud-native and software-defined solutions, and the expansion into AI with significant R&D and acquisition costs (e.g., Juniper Networks acquisition), may impact net margins if the anticipated revenue growth or cost synergies do not materialize as expected.

Valuation

• The analysts have a consensus price target of $22.39 for Hewlett Packard Enterprise based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $29.0, and the most bearish reporting a price target of just $18.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $34.4 billion, earnings will come to $2.2 billion, and it would be trading on a PE ratio of 16.9x, assuming you use a discount rate of 8.4%.
• Given the current share price of $21.53, the analyst's price target of $22.39 is 3.8% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.