Why is HPE stock falling despite stronger-than-expected results, raised guidance?

Hewlett Packard Enterprise raised its annual forecasts on Wednesday after delivering a stronger-than-expected July quarter, as accelerating demand for artificial intelligence infrastructure lifted server and networking sales.

However, shares fell over 5% during extended trading as investors were likely assessing how sustainable the margin gains will be as AI systems make up a larger share of the product mix and supply constraints remain.

HPE reported quarterly revenue of $12.2 billion, a 34% increase from a year earlier and above the $12 billion analysts expected, according to FactSet.

Adjusted earnings came in at $1.11 per share, well ahead of the 93 cents expected.

The company's cloud and AI business generated $9 billion in revenue, up 25% year over year.

Server revenue rose 35% to $6.8 billion, while storage revenue increased 10% to $1.3 billion.

HPE supplies both conventional data-center servers and AI-optimized systems incorporating processors and accelerators such as Nvidia's graphics processing units.

The strength of server demand therefore provides another indication that companies continue to expand computing capacity to support AI workloads.

The results also follow stronger forecasts from rivals including Dell Technologies and Super Micro Computer, as technology companies collectively prepare to spend more than $730 billion on AI infrastructure this year.

HPE raises forecasts as enterprise AI adoption expands

HPE's upbeat results prompted the company to raise its outlook for both the current fiscal year and fiscal 2027.

For the October quarter, HPE expects revenue between $13.9 billion and $14.8 billion, putting the midpoint above the $13 billion FactSet consensus.

Adjusted earnings are expected to range from $1.20 to $1.30 per share, also above analysts' forecast of $1.07.

For fiscal 2026, HPE now expects revenue growth of between 34% and 37%. Its networking business is expected to grow by 73% to 74%.

The company also raised its fiscal 2027 revenue growth forecast to between 13% and 17%.

That longer-term outlook suggests HPE expects AI demand to remain an important growth driver even after the current spending cycle matures.

"It's clear to us that the market, the tailwinds in AI, particularly the adoption of AI in the enterprise, is really starting to settle in," Myers said. HPE expects enterprise adoption of AI to continue supporting growth beyond the current fiscal year.

Supply constraints create a margin challenge

The biggest issue facing HPE may be its ability to meet demand profitably.

Chief Financial Officer Marie Myers said component shortages remain a constraint, with memory representing the biggest bottleneck, followed by NAND, CPUs and drives.

"Demand is far outstripping supply," Myers told Reuters.

HPE has responded by signing longer-term supply agreements designed to improve access to critical components.

But shortages could still affect the company's ability to fulfill orders and maintain margins.

Management expects operating margin to decline sequentially in the October quarter, partly because of the changing product mix and pricing.

"We expect our operating margin rate to decline sequentially, driven primarily by a higher mix of AI systems in cloud and AI and pricing," Myers said on the earnings call.

That could explain why investors were not more enthusiastic about an earnings report that otherwise exceeded expectations.

Inventory rises as HPE prepares for demand

HPE is also building inventory to support higher orders and its growing backlog.

Inventory stood at $11.82 billion at the end of July, up significantly from $7.16 billion a year earlier.

Myers attributed the increase to "higher commodity costs and targeted purchases to support increased orders and increased backlog," Reuters reported.

Higher inventory can help HPE secure the components needed to fulfill customer orders, particularly when suppliers remain constrained.

But it also ties up capital and exposes the company to potential risks if demand slows or component prices fall.

For now, management appears confident that demand will remain strong enough to justify the additional inventory. The AI infrastructure race is broadening.