Light At The End Of The Tunnel: After A Disappointing Quarter, Dell Has Upside Potential

Nov.16.12 | About: Dell Inc. (DELL)

Dell Inc. (NASDAQ:DELL) reported its quarterly results yesterday, missing earnings and revenue estimates. The performance of the PC business was below par, but Data Center product revenue gives hope for the future of the company. The Enterprise segment is characterized by high margins, in contrast to the PC segment where Dell faces a year-over-year shipment decline of 13.7%. The company still has approximately $4.2 per share in net cash and is trading at around $9.5. Therefore, we believe Dell has very limited downside and the growth in its Enterprise Solution segment is a positive sign. We are giving a buy rating to Dell, and believe that these results indicate that HP (NYSE:HPQ) will miss its earnings estimates of $1.14.

FY Q3 2013 Results

The market was expecting EPS of $0.4 on sales of $13.9 billion. EPS estimates varied between $0.36 and $0.44. The company missed consensus earnings estimates and reported EPS of $0.39. Revenue for the quarter was $13.72 billion, approximately 3% below estimates. This is the third time Dell has missed its earnings estimates in the last five quarters. GAAP net income for the quarter was $589 million, i.e., $0.27 per share. The company also announced that during the quarter, cash flow from operations was $1.3 billion.

Revenue decreased 11% year over year, from $15.3 to $13.7 billion. This 11% decrease was driven by a reduction in revenue from Desktop and Mobility segments. The year-over-year reduction in operating income of 48% was much higher. Net Income decreased from $893 million in the same quarter of last year to $475 million, a decrease of 47%. GAAP EPS have also decreased 45% to end up at $0.27 from $0.49. The year-over-year reduction in non-GAAP EPS was much lower at 28%.

The good news for investors was the improvement in Dell's Enterprise Solutions and Services revenue, which grew by 3% year over year to end up at $4.8 billion. The company expects its Enterprise Business to hit $20 billion in annual sales. According to company disclosures, its Enterprise Business is responsible for more than 50% of total gross margin. Servers and Networking revenue for the quarter also saw an 11% increase. The twelfth generation line was instrumental in driving this growth, along with hyper-scale infrastructure and cloud solutions.

Revenue from Large Enterprise units fell approximately 8% to end up at $4.2 billion. Public revenue and Small and Medium Business revenue also saw declines of 11% and 1%, respectively. During the current quarter, Consumer revenue was $2.5 billion, representing a major decline of 23%, as expected, due to weak PC sales. The operating loss from the segment was approximately 2.7% of total revenue of $65 million. Dell is trying very hard to diversify its PC-heavy business model with its Data Center products. The current miss and poor performance year over year was because the growth in Data Center products was not enough to offset the PC slump.


The market was expecting year-end EPS to be around $1.73, but the company has forecast non-GAAP EPS to be around $1.7. The company expects revenue to show sequential growth of 2%-5%. According to a report by Gartner, PC sales have declined by 8% year over year. This reflects the bleak future of the PC industry. Computing is shifting to handheld devices and Dell has not been able to diversify into tablets and smartphones in the same way that Samsung has.

The largest PC maker in the world, Hewlett-Packard (HPQ) is also focusing on tablets to ensure a stake in the rapidly changing computing industry. Microsoft (NASDAQ:MSFT) has also finally realized the significance of this game changer and has shifted away from its classical Windows user interface to a new touch-based interface -- i.e., Windows 8. According to Gartner, Dell shipped 9,216,638 units in Q3 2012 as compared to 10,676,513 in Q3 2011, signifying a reduction in its total market share from 11.2% to 10.5% and showing negative growth of 13.7%. The company has taken a different path than HPQ to account for the PC slump by focusing on Data Center products. The numbers for this quarter show that this strategy has not been as successful as Dell was hoping it to be.


The company has around $7.3 billion in net cash, which comes down to approximately $4.2 per share (1.73 billion outstanding shares) and the stock is currently trading at $9.0 per share ($8.1 per share in total cash). Therefore, we believe the stock does not have a significant downside and the growth in Data Center products is encouraging. The company faced a slump in PC sales due to reduced PC demand in Q3 as people were waiting for Windows 8 to be launched. Sales figures should improve during the current quarter, which reflects the significance of this quarter in terms of the future of the PC industry. High-cost competition and low margins are problems that manufacturers such as Dell are facing. Therefore, the high margin Enterprise segment should increase Dell's profitability in the long run.

The abysmal PC segment results for the quarter will lead to low expectations from HPQ when they report on the 20th of this month. HPQ has also been facing troubles from its deteriorating printers business, along with a 16.4% decline in PC sales year over year. HPQ's cash position is not as strong as Dell's, with net cash per share of $1.9 -- i.e., 14% of current price. Dell's results indicate that HPQ will not be able to meet its $1.14 consensus EPS estimates.

We maintain our buy rating on Dell despite an abysmal quarter due to limited downside potential. We also like its encouraging performance in the Enterprise Solutions segment, cheap valuation (forward P/E of five times), and the positive effect expected from Windows 8 on future PC sales.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Qineqt's Technology Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.