$HPE Fiscal Q2 Preview

by Dan May 23, 2016 3:30 pm • Commentary• Trade Ideas

Event: Hewlett Packard Enterprises (HPE) reports their third quarter as a standalone company tomorrow after the close.  The options market is implying about a 7% one day move following results.  Back in early March the stock rallied 13.5% following their fiscal Q1 results, and the stock declined 1% the day following their Q4 results back in mid December.

With the stock around $16, the May 27th weekly straddle (the 16 strike call premium plus the 16 strike put premium) is offered at about $1.15. If you bought that, and thus the implied earnings move, you would need a move above $17.15, or below $14.85 to make money, or about 7% in either direction.  

Price Action / Technicals: HPE is up about 6% on the year. There is obviously not a ton of history here, 30% from its all time lows made in mid Jan, and down about 13% from its all time highs back in early April.  The chart below dating back to its initial trading day in late October shows the apparent technical resistance at $18.50, and what could be viewed as technical support back down at the gap level following their Q1 results in March back at $14:

[caption id="attachment_63850" align="aligncenter" width="600"]HPE since Oct spin from Bloomberg HPE since Oct spin from Bloomberg[/caption]

Implied Volatility Snapshot: with little trading history comes the challenge of figuring out what is the right level for options prices.  Aside from the sharp move in Jan, the stock has not moved a whole heck of a lot, with 30 day realized volatility at all time lows, just below 19%, while 30 day at the money implied volatility is more than double at 42%:

[caption id="attachment_63852" align="aligncenter" width="600"]HPE chart of 30 day atm IV vs Realized vol from Bloomberg HPE chart of 30 day atm IV vs Realized vol from Bloomberg[/caption]

Implied volatility is likely to come back towards 30% after the report.

Sentiment: Wall Street analysts are fairly mixed on the stock with 12 Buy ratings, 23 Holds and 1 Sell with an avg 12 month price target of about $17.50, about 9% higher than where the stock is currently trading.  Short interest sits at about 1% of the float.

Estimates and Forecasts from Bloomberg:

-2Q adj. EPS est. 42c (range 40c-44c); co. forecast 39c-43c (March 3)
-2Q rev. est. $12.33b (range $12.0b-$12.63b)
-2Q FCF est. $991m

-3Q adj. EPS est. 48c
-3Q rev. est. $12.62b

-FY16 adj EPS est. $1.88 (range $1.80-$1.94); co. forecast $1.85-$1.95 (March 3)
-FY16 rev. est. $50.76b (range $49.21b-$51.84b)
-FY16 FCF est. $2b (range $1.3b-$2.24b), co. forecast $2b-$2.2b (March 3)

My View into the Print: HPE is a cheap stock trading about 8.5x expected 2016 eps of about $1.90 with an expected $50.7 billion in sales. HPE trades .55x expected 2016 sales, vs IBM at a bout 1.8x sales and 11x expected 2016 eps.  But the problem near term for HPE is their exposure to businesses which have demonstrated weak demand, as evidenced by Q1 results from Intel, IBM, EMC, JNPR & MSFT for servers and storage.  Much of HPE’s services and cloud business is dependent on hardware growth.

Currency will continue to be a big swing factor. With more than 50% of their sales from outside the U.S. the movement of the dollar will have an impact on eps and sales, but since their last guide, the DXY is down about 2.5% which could provide a tailwind for now.

HPE is thought to be the better HP from the spin with their focus on higher growth and margin businesses like software, storage and private clouds, but HPE does not have a ton of traction in public clouds like Amazon’s AWS that is growing so quickly.

CEO Meg Whitman is experienced in shaving costs from the prior combined entity, and has committed to continue to do so with HPE as the company’s operating margins are only high single digits.

I expect a fairly mixed bag when the company reports and guides, but cheap valuation and commitment to capital return  (previously guided to using 100% of their free cash flow for cash return in fiscal 2016) should put a floor in the stock in the low teens.

We will update this post tomorrow with some trade ideas prior to the print.