HPE's $7.6 Billion AI Backlog Is Waiting on Memory Supply to Catch Up

Hewlett Packard Enterprise (NYSE: HPE) supplies the servers, networking gear, and storage that businesses and governments need to run artificial intelligence (AI) applications in their own data centers. The company reported record third-quarter results last week, leading management to raise its full-year outlook. HPE also bumped up its fiscal 2027 guidance, projecting at least $5 billion in free cash flow for the year.

In Q3, revenue grew 34% year over year to $12.2 billion, and adjusted earnings jumped 152% to $1.11 per share, driven in part by higher gross margins. Management expects margins to settle at lower levels as AI systems account for a larger share of shipments. Total AI orders of $3.1 billion in the quarter pushed the backlog to $7.6 billion, and bookings for traditional servers were up 75% as customers purchased AI-enabled hardware.

With demand at record highs, backlog growth is outpacing actual shipments as memory and storage drives remain in short supply. That suggests new investment potential for this veteran tech giant.

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Rising demand meets a supply ceiling

CEO Antonio Neri warned that tight supply has been an issue all year and will likely "last for a longer period of time, which obviously will have consequences on cost and pricing." The mismatch is most evident in the networking segment, where orders grew 36% year over year while normalized revenue was up just 10%.

The growth converting to revenue is largely driven by price. Server revenue grew 35%, driven primarily by higher average selling prices fueled by higher input costs. Actual product shipments were limited, though management expects some improvement in the fourth quarter.

Gross margin hit a new high of 40.4%, which the CFO described as a "confluence of everything coming together at once." As the company ships more AI systems, which carry lower margins than traditional servers, management expects profitability to trend back down toward historical rates.

HPE's structural networking edge

The company's networking business, which now accounts for roughly 30% of total operating profit, should help offset some of the supply-driven margin pressure. Networking carries higher margins than the company average and is expected to land in the mid-to-high 20% range for fiscal 2027, compared to around 13% for the server segment.

The segment is benefiting from the integration of Juniper Networks and is winning large deals, including a multi-gigawatt deployment of its routers and switches for Oracle's AI data centers. HPE also has an opportunity to supply the switches for AMD's Helios rack-scale systems.

HPE remains a solid way for investors to play the build-out of on-premises AI infrastructure. The primary risk is that supply constraints prove worse or last longer than expected, slowing the conversion of orders into revenue.

The company has locked up memory capacity through long-term supply agreements and expects components to start aligning with its order book in the current quarter. For investors with a multiyear time horizon, the stock is attractive today at just 12 times forward earnings.

Bryan White has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Hewlett Packard Enterprise and Oracle. The Motley Fool has a disclosure policy.