2023-10-30 08:46:38 ET
Summary
- HP split into two separate companies, HP Inc. and Hewlett Packard Enterprise, in 2015 to focus on PC and server businesses, respectively.
- Both companies are diversified but HP Inc. has a more strategic focus with consolidated segments and a better growth outlook.
- HP Inc. has dominant market positions in PC and Hardcopy Peripherals, while Hewlett Packard Enterprise faces intense competition in the server market.
Hewlett Packard ('HP') was founded in 1939 and operated traditionally as a PC manufacturer and diversified to related businesses over the years. In 2015, HP split into two separate companies HP Inc. ( HPQ ) and Hewlett Packard Enterprise ( HPE ) enabling both companies to be more focused, with HPQ handling PC and related businesses and HPE handling server and related businesses. Having both companies in our portfolio, we analyze them both to examine how they have evolved since the split and which company has emerged stronger.
Which Company Has Better Segments?
We analyze both companies in terms of segment breakdown to understand how diversified or focused each company is.
Diversification
Company Data, Khaveen Investments Company Data, Khaveen Investments
We can see that both companies are diversified with HPE operating 6 segments while HPQ operates 8 segments. From the table below, we can also see that both companies' revenue by geography is almost identical, indicating very similar distribution and marketing channels.
Revenue Breakdown by Geographic Region (Q3 2023 YTD) | HPQ | HPE |
Americas | 42.7% | 42.9% |
Europe, Middle East and Africa | 33.4% | 34.9% |
Asia-Pacific and Japan | 23.9% | 22.2% |
Source: Company Data, Khaveen Investments
However, this does not accurately paint a picture of how these companies actually serve the markets. To understand deeper, we reclassified both companies' segments according to GICS classification according to Sectors, Industry Groups, Industries, Sub-industries, and Markets.
As seen above, all segments across both companies are within the Information Technology Sector except for HPE's Financial Services segment. Breaking down to the end markets, HPE's segments consolidate into 5 end markets from 6 segments. HPQ on the other hand sees its 7 segments consolidated down to just 3 end markets (PC, Computer Peripherals, Hardcopy Peripherals). Thus, we believe the splitting of HPQ and HPE resulted in a much more strategic focus for HPQ.
Growth
We recategorized all segment revenue based on the end markets of each company we identified, as below:
Company Data, Khaveen Investments
HPE Revenue Breakdown ($ mln) | 2018 | 2019 | 2020 | 2021 | 2022 | 4-year Average |
Server | 17,491 | 16,193 | 14,905 | 15,070 | 15,597 | |
Growth % | -7.42% | -7.95% | 1.11% | 3.50% | -2.69% | |
External Storage | 5,054 | 5,183 | 4,589 | 4,678 | 4,654 | |
Growth % | 2.55% | -11.46% | 1.94% | -0.51% | -1.87% | |
Enterprise Network Infrastructure | 2,997 | 2,901 | 2,855 | 3,292 | 3,665 | |
Growth % | -3.20% | -1.59% | 15.31% | 11.33% | 5.46% | |
IT Consulting | 1,654 | 1,285 | 1,293 | 1,356 | 1,254 | |
Growth % | -22.31% | 0.62% | 4.87% | -7.52% | -6.08% | |
Finance Leasing | 3,656 | 3,573 | 3,340 | 3,388 | 3,326 | |
Growth % | -2.27% | -6.52% | 1.44% | -1.83% | -2.30% | |
Total | 30,852 | 29,135 | 26,982 | 27,784 | 28,496 | |
Growth % | -5.57% | -7.39% | 2.97% | 2.56% | -1.86% |
Source: Company Data, Khaveen Investments
For HPE, its 4-year average growth was just -1.86%. Most of its segments remained flat. Enterprise Network Infrastructure was the only segment with a positive 4-year average growth, but it was not enough to offset the decline of all the other segments.
Company Data, Khaveen Investments
HPQ Revenue Breakdown ($ mln) | 2018 | 2019 | 2020 | 2021 | 2022 | 4-year Average |
PC | 37,661 | 38,694 | 38,997 | 43,359 | 44,084 | |
Growth % | 13.02% | 2.74% | 0.78% | 11.19% | 1.67% | 4.1% |
Hardcopy Peripherals | 20,805 | 20,066 | 17,641 | 20,128 | 18,902 | |
Growth % | 11.09% | -3.55% | -12.09% | 14.10% | -6.09% | -1.9% |
Total | 58,470 | 58,756 | 56,639 | 63,487 | 62,983 | |
Growth | 12.34% | 0.49% | -3.60% | 12.09% | -0.79% | 2.0% |
Source: Company Data, Khaveen Investments
For HPQ, the company had a 4-year average growth of 2%. This was contributed positively by its PC segment and negatively by its Hardcopy Peripherals (printer) segment. In our previous analysis of HPQ, we already explained the reason for the sluggish growth of the Hardcopy Peripherals market which was due to the general shift from print media to online media.
Outlook
Based on our segment classifications, we obtained the forward outlook of both companies based on the forecasted CAGRs of each market.
Market | Forecast CAGR | Source | HPE % Revenue | HPQ % Revenue |
PC* | 3.6% | N/A | 62.3% | |
Hardcopy Peripherals | -1.9% | N/A | 30.0% | |
Computer Peripherals** | 6.5% | Growth Market Reports | N/A | 7.7% |
Server | 1.1% | 54.73% | N/A | |
External Storage | 3.4% | IDC | 16.33% | N/A |
Enterprise Network Infrastructure | 5.3% | Precedence Research | 12.86% | N/A |
Finance Lease | 5.1% | Grand View Research | 11.67% | N/A |
IT Consulting | 5.1% | Statista | 4.40% | N/A |
Weighted Average CAGR | 2.65% | 2.18% |
Source: Company Data, Growth Market Reports , IDC , Precedence Research , Grand View Research , Statista , Khaveen Investments
*Estimated based on the PC market size (Statista) multiplied by HP's PC market share ('IDC')
**Estimated by subtracting our HPQ PC revenue estimate from its Personal Systems segment revenue
The weighted average outlooks of both companies do not look very good. HPQ's forecasted growth of 2.18% is worse than HPE's, but not by much. Considering the latest Q3 earnings by both companies, HPE's TTM (Q3) growth of 6% is much better than HPQ's growth of -15.5% over the same period. We are not surprised about HPE's growth as we previously already covered the PC market slowdown. However, we would have thought HPE would also have had negative growth in line with the server market. We found the reason for the strong revenue growth was its Intelligent Edge segment which grew by 40% YoY in YTD 2023.
We believe HPQ's outlook is more grim. While the company highlighted in its latest earnings briefing , for PC "that most of the headwinds are temporary", the picture for the Printing segment was more dire.
We have seen a significant decline of units and it's in the range of 20%. And this clearly will put more pressure on the Print business going forward. It's not a short-term impact. It's really more a medium and long-term impact. - Enrique Lores, President and CEO of HPQ
HPE reiterated its prior FY23 guidance of "4% to 6% revenue growth in constant currency". We believe this is achievable, as it is just slightly higher than our forecast.
Market Dominance Comparison
While HP decided to split its PC and server businesses, their major competitor Dell (PC maker), instead decided to acquire EMC (server maker) in 2016, to consolidate both businesses. Similarly, Lenovo ( LNVGY ) also has both its PC and server business under the same roof, having acquired IBM's ( IBM ) server business in 2014, adding to its already established PC business. As such, even though HP has split into two, they face similar competitors in each market they operate in. We analyzed the market positions of HPQ and HPE in their top markets to determine if either company has an edge over their competition.
HPE
In the server market , HPE has seen its market share dwindle since 2010. Its share began to decline even more rapidly after the split in 2015, despite establishing H3C, a Chinese JV with Unisplendour Corp. We believe this is due to competition from Chinese server maker Inspur and other ODM manufacturers. Interestingly, both Lenovo and Dell ( DELL ) who maintained their server business in-house, have managed to maintain their market shares. Despite the US adding Inspur to the export ban list this year, we believe this would not benefit as HPE also announced the sale of H3C this year, which we believe is a result of similar geopolitical pressures.
IDC, StorageNewsletter, Statista
In the External Storage market , HPE has maintained its market share, but so has Dell (which has a 3x larger market share). We expect Dell to remain the market leader here with HPE maintaining its current share moving forward.
In the Enterprise Network Infrastructure market , HPE has a higher market share (5%) than Dell but is miles behind market leader Cisco ( CSCO ) (41%).
HPQ
Gartner, VentureBeat, HardwareZone, MacRumors, GizChina, Statista
In the PC market , the top layers have gained over the years at the expense of smaller manufacturers. The top 3 PC makers (Lenovo, HP, Dell) now control 62% of the market. All 3 have gained market share but have reached a point of stability in recent years.
The Hardcopy Peripherals market sees the top 3 players (HP, Canon ( CAJPY ), Epson ( SEKEY )) maintain their shares over the years, but HP clearly dominates with around 37% market share. However, as mentioned earlier, the market has been sluggish due to shifts to online media.
Outlook
We see that HPQ has more dominant and established positions in its main markets compared to HPE. We expect HPQ to maintain its leading market positions in the Hardcopy Peripherals and PC markets. For HPQ, we believe it could maintain market shares in external OEM storage and network infrastructure but could lose market share in the server market due to the intense competition.
Fi na ncials Comparison
Margins
Company Data, Khaveen Investments Company Data, Khaveen Investments
As seen from the charts above and the table below, HPE's gross margins are much higher than HPQ's (32.2% vs 19.28%). Interestingly, this advantage disappears as we get to the bottom line, as HPE's EBIT, Net and Free Cash Flow margins are all lower than HPE's.
Profitability Margins (5-year Average) | HPQ | HPE |
Gross Margin | 19.28% | 32.20% |
EBIT Margin | 7.82% | 7.19% |
Net Margin | 6.96% | 4.79% |
Free Cash Flow Margin | 5.82% | 4.61% |
Source: Company Data, Khaveen Investments
To understand further, we look into the operating margins of each company's segments. For HPE, its top 4 segments all have similar operating margins which are in the mid-teens. For HPQ, the Hardcopy Peripherals (Printing) segment has a high 19.3% margin compared to its other segment despite consisting of just 30% of its revenue.
HPE Segment 2022 | Operating Margins | Revenue Contribution | Weighted Margin |
Compute | 14.2% | 43.93% | 6.2% |
Storage | 14.7% | 16.33% | 2.4% |
Intelligent Edge | 15.0% | 12.86% | 1.9% |
Financial Services | 12.0% | 11.67% | 1.4% |
HPC & AI | 0.4% | 10.80% | 0.0% |
Corporate | -7.3% | 4.40% | -0.3% |
Total | 100.00% | 11.7% |
Source: Company Data, Khaveen Investments
HPQ Segment Operating Margins | 2022 | Revenue Contribution | Weighted Margin |
Personal Systems | 6.6% | 70.0% | 4.62% |
Printing | 19.3% | 30.0% | 5.80% |
Total | 100% | 10.05% |
Source: Company Data, Khaveen Investments
We find HPE's margins more stable given the relatively stable distribution of margins across its business segments, whereas HPQ's margins are more dependent on Printing despite being the smaller segment.
Cash Flow
Company Data, Khaveen Investments Company Data, Khaveen Investments
Looking at the cash flows of the company, we now understand how HPE's gross margin advantage disappears. HPE has a much higher 5-year average capex spend than HPQ ($2.7 bln vs $0.6 bln), despite HPQ's revenue being 2.2x larger than HPE's ($62.9 bln vs $28.5 bln). The higher capex spend is due to the difference in manufacturing approaches of both companies where HPQ outsources the majority (95%) of its production while HPE maintains facilities in-house across the world and has been expanding its footprint, such as the expansion of a manufacturing facility in the Czech Republic for servers.
Financial Position
Company Data, Khaveen Investments Company Data, Khaveen Investments
Both companies have seen their cash-to-debt ratio fall over the years. Both companies have less than 10 cents of cash for every $1 of debt they hold.
Outlook
While we favor HPQ's business model of outsourcing production that allows the company to be asset-light with much lower capex and this translates favorably to its free cash flow margins, we believe HPE's margin mix is more stable and could allow for more margin expansion compared to HPQ. HPE highlighted it is working on optimizing its cost structure and aims to "reduce structural cost by $1.4 billion", with 40% of these savings expected to be achieved in FY23. For HPQ, we believe that overall company margins could decline as the Printing segment (higher margins) faces more prolonged market weakness than the PC segment (lower margins).
Risk: Competition
As mentioned above, both HPE and HPQ are among the top companies in the server and PC markets respectively. However, we believe both companies could face strong competition from key competitors. In the server market, ODMs such as Foxconn ( FXCOF ) are benefitting from direct purchases from cloud service providers such as AWS ( AMZN ), Azure ( MSFT ), and Google Cloud ( GOOG ) for data centers instead of traditional server makers according to the IDC. Whereas in the PC market, although the top 3 companies including HP have stabilized in recent years, we believe Apple ( AAPL ) is still a rising threat to HP due to its branding strength, customer satisfaction, and superior product quality as highlighted in our previous analysis as well as a refreshed product lineup of MacBooks in 2023.
Verdict
Overall, we believe HPQ has benefited more from the split, with a more focused business that has left it with leading market positions in the only two markets it operates in (PC and Hardcopy Peripherals). HPE on the other hand has pivoted to more diversified end-markets with smaller market leadership positions and could see its share decline in its main market segment (Server). In terms of overall growth, we see HPE edging out HPQ though not by much. While we expect the PC market to recover, which bodes well for HPQ, we forecast prolonged weakness in its printing segment, which is also in line with management guidance. The weak printing segment also has a deteriorating effect on HPQ's overall margins, given the much higher margins in Printing than PC. HPE has the advantage here, as although it has higher capex costs, the operating margins across all its main segments are relatively high.
Company | HPQ | HPE |
Price Target | ||
Upside | 16.97% | 18.37% |
Rating | Buy | Buy |
Source: Seeking Alpha
Based on analyst consensus, the upside of both companies is around 17 to 18%. However, we believe this is not due to the outlooks of the companies, but instead a result of the share prices of both companies dropping significantly below their target prices over the past month. As such, we rate both HPE and HPQ companies as a Buy , mainly due to their recent share price drops, which could provide an opportunity for short-term gains.
For further details see:
HPE Vs. HPQ: Which Is The Better HP Stock?