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Stocks To Watch in Information Technology: Hewlett Packard Enterprise Co. and IBM

By Leo Sun – Dec 15, 2015 at 1:09PM

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Investors shouldn’t ignore these two slow-growth IT stocks.

The IT market is a massive one, encompassing enterprise hardware, data center systems, and services across the world. The industry was once a high growth sector, but has since lost its momentum due to market saturation, thriftier IT departments, and a shift toward cloud-based services.

Research firm Gartner estimates that global IT spending will fall 4.9% annually this year due to sluggish demand and a strong dollar. Despite that bleak forecast, tech investors should keep an eye on two interesting IT stocks -- IBM (IBM -0.04%) and Hewlett-Packard Enterprise (HPE -0.49%) -- to better understand the overall market.

As one of the biggest IT companies in the world, IBM has been hit hard by sluggish IT spending worldwide. Big Blue's revenue has fallen for 14 consecutive quarters, due to weak demand for its IT services, hardware, and software. Last quarter, its total revenue from continuing operations fell 14% annually. Excluding currency impacts and the sale of its System x business to Lenovo, sales were down 1%.

An IBM-powered data center. Source: IBM.

On the surface, IBM's growth looks dismal. IT services revenue fell 10% annually last quarter, software revenue declined 10%, and hardware revenue plunged 39%. But within these segments, IBM's "strategic imperatives" revenue, which comes from its cloud, analytics, mobile, social, and security businesses, rose 17% annually, or 27% excluding currency impacts and the System x divestment. The annual run rate for IBM's cloud services also rose 45% annually to $4.5 billion.

While double-digit gains within those pockets of growth were encouraging, they weren't enough to offset the losses in IBM's other aging businesses. IBM believes that revenue from its strategic imperatives, which accounted for 27% of its top line in 2014, could generate 44% of its revenues by 2018.

To achieve that goal, IBM made 11 major acquisitions in 2015 to beef up those businesses. It's also expanding its Open Power program to "open source" its high-end server and mainframe designs to encourage more OEMs to buy its Power processors instead of Intel's (INTC -6.41%) Xeon chips. High sales of Power processors and its high-end mainframes could prop up IBM's hardware sales.

Investors shouldn't expect IBM to bounce back anytime soon, though. Analysts expect IBM's annual revenue to fall 12% in fiscal 2015 before posting a milder 2% decline in 2016. But after dropping 16% over the past year, IBM stock remains fairly cheap at 9 times earnings.

Hewlett-Packard Enterprise
In early November,Hewlett-Packard Enterprise split with HP Inc and retained the company's enterprise hardware, software, and tech services.

Source: HPE.

During its final quarter as one big company, HPE's revenue fell 4% annually to $14.1 billion. On a constant currency basis, revenue would have risen 3%. Revenue at HPE's Enterprise Group, which sells servers, storage, and networking hardware to businesses, rose 2% to $7.4 billion. Revenue from servers and networking hardware respectively rose 5% and 35%. However, revenue from storage solutions, business critical systems, and technology services all declined. HPE's Enterprise Services revenue, which comes from outsourced IT, application, and business services, also fell 9% annually to $5 billion.

Back in October, HPE shuttered its public cloud platform in October due to competition and cost concerns. Instead of focusing on public cloud solutions, HPE is expanding its presence in the "hybrid cloud market" which merges private and public clouds for customers who aren't ready to move all their data to the public cloud yet. Gartner expects half of all large enterprises to have hybrid cloud deployments by 2017.

To remain exposed to the public cloud market, HPE recently struck a major cloud deal with Microsoft (MSFT 0.07%) to become a "preferred provider" of its hybrid cloud offerings and other infrastructure services. That move will also give Microsoft's fledgling cloud platform Azure the support of HP's massive enterprise and IT base. HPE also recently partnered with Intel to create new products which sit outside data centers at the "edge" of networks to "collect, process, as well as analyze data" from Internet of Things devices.

Despite signing these promising deals, HPE's earnings guidance for the first quarter remained below consensus estimates, although its outlook for fiscal 2016 remained in line with expectations. Looking ahead, HPE intends to return over half of its estimated free cash flow in fiscal 2016 to shareholders, and has allocated $400 million to dividends and the rest to buybacks.

The key takeaway
Neither IBM nor HPE looks like an appealing investment today, but both companies could bounce back if their growth initiatives work out. For IBM, the expansion of its Watson AI platform and the Bluemix cloud platform could finally help its sales growth return to positive territory again. For HPE, new partnerships with Microsoft and Intel could ensure that it remains an integral part of hybrid cloud upgrades for large enterprise customers.


Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Gartner and Intel. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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