Why Dell Is a Great Value at These Levels

Dell, Inc. (DELL) closed Monday’s trading near a 12 year low at about $8 per share, adjusted for splits. Shares are roughly a third of where they were last summer, and since then the company has been on a downward spiral. The company reports fourth quarter and full year fiscal 2008 results on Thursday afternoon, and already many sources including the Wall Street Journal and Barron’s have begun to dampen expectations.

Dell is dealing with quite a few difficulties right now, chief among them is the fact that PC sales have dropped off quite a bit recently. Dell gets more than 60% of its revenue from the PC segment of their business. In addition, with one of Dell’s main competitors Hewlett-Packard (HPQ) reporting disappointing earnings last week, Dell could be dealing with many of the same troubles. (Click to enlarge)

Dell has undergone a change in strategy as the company originally made its name as a direct sales retailer. In 2007, Dell began partnering with big box retailers including Walmart (WMT), Best Buy (BBY), and Costco (COST). The shift in strategy aligned with the return of the company’s founder, Michael Dell, who resumed his post as CEO that he had left a few years before. It is unknown exactly how well this shift has worked because the macro-economy declined greatly soon after Dell partnered with the retailers.

Michael Dell’s other major change was to cut costs as they had become a real drag on the company’s performance. Dell has worked to improve efficiency and has cut more than 10,000 jobs since Michael Dell’s return. Operating expenses dropped 12% in the last quarter, and hopefully that trend will continue in Thursday’s results. This cost cutting has proved absolutely necessary as margins have been squeezed in the industry for two reasons: major competition for PC sales leading to price wars, and consumer preferences have shifted to cheaper computers as consumer spending has slumped.

Margins are certainly a concern, but Dell is not shying away from the cheaper PC market. Dell is an industry leader in the new Netbook trend.

Netbooks are smaller, more basic computer models that do not need all the computing power that is available in many of today’s laptops. Netbooks are a key product to emerging markets because they have enough computing power for simple tasks at a much lower cost.

We wrote about this trend in Dell sales in May of last year (Dell Turnaround Stocked by Emerging Market Sales). The dollar has strengthened significantly since then, so that could be of some concern as well but we are confident that the trend to Netbooks is here to stay. Dell is also looking to diversify their products, and a smart phone is supposedly in the late stages of development. However, we will stick with what we can observe through available data at this time.

As you can see from our historical valuation chart for Dell, we have believed this stock was Undervalued for some time. It has now reached our most bullish valuation of Greatly Undervalued. It is not hard to see that Dell has been crushed during this downturn, but you may not have realized that Dell actually has $8.5 billion in cash and equivalents as of the end of the last quarter. That means that the company had more than $4 per share in cash as of last quarterly report, with a relatively small debt burden as well (less than $2 billion in long term debt). The company has been using some cash to buy back stock, which is a decent plan with valuations this low.

So even if Dell results come in Thursday at $1.23 EPS, the lowest estimate of all analysts for the full year, then the non-cash portion of the stock is selling for little more than 3 times earnings.

The stock is simply dirt cheap, and even if the company does not have the growth potential that it used to, it is a great value at these levels. The last time Dell was selling at less than $10 per share they had less than one-sixth the revenue they currently do.

For further demonstration of Dell’s valuation, over the last ten years Dell has traded in a price-to-sales range of .8x to 1.38x, but the current price-to-sales is a shocking .25x. Likewise, the current price-to-cash flow is a miniscule 3.7x compared to the historically normal range for Dell of 12.6x to 21.7x. So, as you can see, unless you think that Dell is going bankrupt–which seems unlikely with more than $4 per share in cash and little debt worries–then the downside risk here is minimal for the long term investor.

Comments

[cityp3:]

Have you looked at what DELL stock would be worth today if they liquidated? Take a closer look at the balance sheet. You'd be left with next to nothing assuming fire-sale inventory prices and and a discount to receivable book value.

While DELL has tons of cash and little debt, take a look at the payables. DELLs negative cash flow model works great when revenues are growing. Payables, however, are 2x receivables. Those payables, while not debt, represent real creditors and DELL needs to pay its suppliers at some point. Don't be surprised to see very weak cash flow as revenue continues to decline. Also don't expect to see major stock repurchases, as management understands its cash dynamic and is likely to be very cautious using cash in this environment.

So yes, DELL looks cheap. But as long as revenue growth is negative, I would not get excited about DELL.

Current TBV per share = $0.85

Feb 24 08:58 AM

[PassingBy55:]

I'd be cautious in buying into a company that has diversified into a new strategy of "retail operations" when consumers are clenching their pocketbooks. I'm sure businesses are renewing leases, but some may be pushing off replacing computers until the winds have cleared.

I'm no expert, but this does not seem like much of a value when you have the sky falling around the world and panic has not set in yet.

Feb 24 10:51 AM