How Morgan Stanley Is Playing HP Post-Split

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  • Hewlett-Packard Company HPQ shares are down 33 percent year-to-date, remaining below the $30 mark since the second week of August.
  • Morgan Stanley’s Katy L. Huberty maintained an Overweight rating for the company, with a price target of $40.
  • Although the combined guidance of HPE and HPI was in-line with low expectations, Huberty believes that the split would foster growth.

A combined guidance for HPE and HPI was announced, with FY16 EPS at ($3.62) and FCF at ($4.8B), in-line with low investor expectations. “Both see growth as a key benefit of the split…We continue to see re-rating post separation with SOTP of $43+,” analyst Katy Huberty said.

HPE: Growth and Margin Expansion Ahead

Hewlett Packard Enterprise’s businesses are being aligned around “four key transformation areas” and this is expected to drive growth and margin expansion. Huberty mentioned the key takeaways as:

  1. With the business stabilizing, the company has projected flat revenue in FY16, with “GDP-like growth longer-term.” Continued stabilization in Enterprise Services [ES] is expected to be the main contributor of this target.
  2. Mix shift toward higher margin storage, networking and Technology Services [TS] are expected to drive margin expansion. Moreover, this could be boosted by margin expansion at ES, with additional restructuring.
  3. ES, TS, Software and Financial Services account of 60 percent of the total segment revenue, which allows for the company to have a large recurring revenue base, with visibility to 50-70 percent of segment revenue.
  4. HPE plans to make organic investments and form partnerships, and following a “disciplined approach” to M&A. This marks a divergence from its intention last year to ramp up the rate of acquisitions.
  5. “An increased focus on consultative sales improves the company’s ability to play in key themes like Hybrid Cloud, Security, Mobile, Big Data,” Huberty wrote.

HPI: Reliable Returns, Robust FCF and Long-Term Growth

HP Inc is likely to generate reliable returns, solid cash flow and long-term growth. In the report Morgan Stanley noted the key takeaways as:

  1. Supplies account for a large part of the company’s profits. HPI plans to invest in “higher usage hardware placements, market adjacencies, while also maintaining strengths in the core (e.g. re-igniting Home printing market),” Huberty said.
  2. The company can address several markets that present large opportunities. The copier market, with $55B TAM, 3D printing and Immersive Computing, with $10B+ TAM, PC adjacencies, with $138B TAM, and Graphics, with $35B TAM, can form avenues of longer-term growth.
  3. Investment focus appears to be more intense than investors appreciated, the report added.
  4. The company has projected fx headwind of $0.34 per share in FY16, attributable in part to “favorable hedges that roll off in 2H15.”
  5. In the current quarter, HP would have extra inventory, accumulated during the separation process. Inventory is expected to return to normal ranges by the end of F1Q16. “With inventory digestion complete, easier comps, less currency headwind, earnings growth is expected to accelerate in F2H16,” Huberty wrote.
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Posted In: Analyst ColorReiterationAnalyst RatingsMorgan Stanley
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