HPE Earnings: Networking and AI Helping To Offset Weaker Server Demand As We Maintain Our $16 FVE

We maintain our $16 fair value estimate for shares of no-moat HP Enterprise HPE, or HPE, after the firm’s fiscal third-quarter results met guidance and the outlook for the fourth quarter met our expectations. HPE continues to enjoy robust networking demand, and is garnering artificial intelligence-related orders for its supercomputers. Standard compute servers (not for AI) and storage arrays are seeing softer demand with customers still working down their own inventories, but we retain a positive view on HPE’s profitability even amid weaker demand. We see shares as fairly valued.

Fiscal third-quarter sales rose 1% year over year and remained flat sequentially at $7.0 billion. Networking products continue to post remarkable growth, with HPE’s edge segment rising 50% year over year in the quarter. Supercomputing sales didn’t show growth, but HPE’s orders imply material growth to come over the next two years, in our view. Standard compute servers, HPE’s largest end market, remained weak and declined 13% year over year. We believe compute weakness is market-driven, in part from inventory digestion at customers and in part from data center customers prioritizing graphics processing unit, or GPU, orders over CPUs.

HPE’s profitability for its compute servers in a downcycle is good, in our view. Compute operating margin was 11% in the quarter, which is at the bottom end of management’s target range, but well above server peers. The firm’s non-GAAP operating margin was 10.3%, which was a step down both year over year and sequentially, but a healthy level, in our view.

Fiscal fourth-quarter guidance calls for sequential sales growth and stable profitability. Management expects sales of $7.35 billion at the midpoint, implying 5% sequential growth, but a year-over-year decline against an extraordinary quarter in fiscal 2022.