A Dell Long Play: Buy the Stock Only When it Comes to You

Nov.24.06 | About: Dell Inc. (DELL)

What’s the scoop with DELL? Buy, Hold or Sell? For an answer, I flipped through some research reports (from the last week). The data was very interesting.

Firstly, here are the reports I reviewed:

- DELL Nov 22 report by Credit Suisse

- DELL Nov 22 report by Bear Stearns

- DELL Nov 22 report by Prudential

- DELL Nov 17 report by Ned Davis Co.

- DELL Nov 17 report by Columbine

Given that these reports (almost all, if not all) were produced after the recent impressive quarterly results were released by Dell, there has been a significant upgrade in EPS estimates for Fiscal Year 2007 and 2008 (Jan. 31) and in the 12-month Price Targets [PT].

dell1

But that’s certainly not the whole story.

I found it interesting that the major Swiss banks (Credit Suisse and UBS) were NEUTRAL and somewhat underwhelmed by the recent performance improvement at Dell, whereas the major U.S. firms, Prudential and Bear Stearns were clearly impressed.

In fact, Prudential seems quite smitten, if that word applies.

The smaller U.S. firms that are billed as independent research (Columbine and Ned Davis) made interesting comments that were on the moderately negative but hopeful side. I’ll insert some of their comments below.

The question I have to ask: Is there a positive bias by American sell-side firms for U.S. headquartered (and managed) companies – just as there may very well be a bias by European or Canadian or Japanese sell-side firms for their own?

I chose those last two words carefully. If you disagree then what you are saying is that when you travel abroad you are not so happy to “get home” and that in your career you are completely unbiased in your decisions and work.

I don’t think that’s possible. But the point I am making is that I frequently observe these biases and take them into consideration when analyzing and making my own decisions.

To what extent there is a bias would be a worthy subject for academia. But for students of the market, we cannot overlook the likelihood that bias does exist here.

For the average Price Target, and EPS 2007e and 2008e of the two huge Swiss banks versus the two very large U.S. firms, there is a clear and present… difference.

The Swiss have averaged the PT and EPS estimates at $26.00 and $1.175/$1.40 while the Americans are at $33.00 and $1.20/$1.53.

These are significant differences for a company (Dell) that, in the words of Value Line, presumably has high (i) Stock Price Stability, (ii) Price Growth Persistence, and (iii) Earnings Predictability.

Then again, maybe it’s just the seeming infatuation by the Prudential Research team for DELL, and I am wrong to bring up the subject of bias.

As I got into the detail of these reports, it became obvious that Dell has become very international, and is mostly winning with its business strategy in China and India. So much so, in fact, that the results are stunning.

Dell is a Cara 100 company on the basis of its superior business model, financial strength, operating metrics, and management. I place it in the Growth category – but not the hyper-growth group of say Google (NASDAQ:GOOG) or the “old growth” of say General Electric (NYSE:GE), which are also Cara 100 companies.

With Dell (NASDAQ:DELL), there is a bit of cyclical growth and turnaround elements to the story, and these are touched upon in the Wall Street reports.

But Dell is a Cara 100 nonetheless.

Dell Inc [GICS 45, Cara 100]

(DELL: Yahoo Finance file)
(DELL: StockChart chart)
(DELL: Investertech chart)
(DELL: ADVFN Financial Data)

What sets this company apart is their direct business model and approach to meeting customer needs. It has made them the number one supplier of personal computer systems in the world.

And they manufacture at many locations around the world, which means that well-designed systems for assembly, software installation, product testing and quality control are localized, close to the customer, especially in fast growing markets like China and India, and that model works.

In 2006, sales outside the U.S. accounted for about 41 pct of revenue. As you are probably aware, the U.S. economy is having some “issues” presently, where unit shipments of computer products like pc’s are flat and margins slipping. But in China and India, just the opposite is occurring.

So when you read these Wall Street reports on Dell, you can either accept the storyline that the company is focusing on profitability ahead of growth or, like me, you can file it under “G” as in garbage. The correct story here is China and India because that’s where the world’s economic growth is happening, and Dell is properly positioned to succeed there.

In the U.S. and America’s region, in the latest quarter, Dell’s unit shipments fell by -5 pct Y/Y and revenue was flat at $9.2 billion. In the EMEA region (Europe, Middle East and Africa), things were better: revenue totalled $3.3 billion, up +6 pct Y/Y on +9 pct growth in unit shipments. But in Asia-Pacific, revenue growth was up +20 pct to $1.9 billion on +23 pct unit growth.

Splitting out this data for China and India, the unit growth was +33 pct and +93 pct respectively.

Overall, the unit growth is in mobiles (+17 pct) and servers (+12 pct), while Desktop systems fell by -5 pct Y/Y.

Credit Suisse points out that operating margins company-wide improved significantly from 4.3 pct to 5.7 pct in the 3Q. They say about Calendar Year 2007, based on a +5 pct revenue growth, earnings per share could swing from a low of $1.00 to a high of $1.80 depending on an operating margin of 4.3 pct or the company achieving its previous peak operating margin of 8.1 pct.

CS is targeting a margin of 6.5 pct to 7.0 pct, which would result in CY07 EPS of between $1.45 and $1.56.

Since CS is pretty close to consensus (a little conservative actually), then let’s project CY07 EPS at $1.50. If we apply a PE multiple range of 15 (low side) to 20 (high side), that leaves us with a 12-month Price Target of $22.50 (low) and $30 (high). Interestingly the average PT of the four big firm research groups is $27.67 and the average of my PT range is $26.50.

The current price is $27.14 after jumping on Wed after release of the current data. Previously, the stock had been averaging about $24.50 for a couple weeks. There is no dividend.

So as I see it the stock is fully priced. There may be some upside, but, after yesterday’s move, the downside risk is greater.

I think the turn in operations has occurred, and that margins will continue to grow, but the bigger issue is the potential for a hard economic landing in the U.S., which will affect foreign markets also. Personal computers are a discretionary purchase. Dell uses the Microsoft operating system, including the new Vista os. Many buyers in tougher economic times will hold off purchases for several months, possibly also waiting for the Vista os bugs to be worked out. In the meantime, the Intel chips will do that much more say six months from now, which adds to one’s inclination to hold off purchases.

Putting that together with the high probability (as I see it) of a Bear market for U.S. equities, I can see a number of negatives taking the stock back to the low 20’s in the next few months. I don’t think it would hit the $18.95 low in the 2002-2006 Bull market, as it did in July, but, as I see it, a purchase of DELL at $20 will soon be possible, especially if supplemented by the receipt of premium on $20 put option writes.

So let’s assume, for purposes of planning ahead, that we can buy DELL at $20. If we could sell it within 12-months at $30, that would be a +50 pct gain. As you know, I try for Buffett type annual performance results, which are about +26 pct, and I never expect to hit the high or the low, so that means I will be avoiding DELL for now, and looking for the right buying opportunity to come to me.

In the interim, I would be keeping a file of all the objective research I could find on this company and paying attention to the interim notes/reports of the qualified people who prepare these research studies. I’d ignore 99 pct of the “noise” in the market.

Before I leave this for you to decide, here are some positives and negatives provided by Ned Davis Research. I met Ned btw in 1981 or 82 in Toronto. I respect his professionalism and his track record.

"While the current rating is neutral for DELL there are some encouraging signs for the stock.

- Asset Turnover supports a positive outlook on DELL. Asset Turnover measures the amount of sales generated for each dollar of assets; it is a measure of the company's efficiency in utilizing its assets. While the significance of this ratio's level can vary from stock to stock, the current reading is bullish for DELL.

- DELL's EBITDA/Enterprise Value is bullish. A higher EBITDA/Enterprise Value signifies that each dollar of a DELL's value is used to generate more earnings (before Interest, Taxes, Depreciation and Amortization). This ratio can be used to compare profitability across companies and industries since it excludes the effects of financing and accounting decisions.

- General stock market confirmation is positive for DELL. Significant research shows that stock market trends that are confirmed by the common stock Advance/Decline line and the number of 52-Week New Highs minus New Lows provide the most reliable moves, while divergences signal a trend change.

There are some negative indications for DELL which are concerns for the current neutral rating.

- Pretax Margin supports a bearish position on DELL; relatively low or declining pretax margins can indicate a problem with pricing strategy or competition in the industry.

- DELL’s Research & Development Expense / Sales is bearish. This ratio shows how much money DELL is putting back into the company through R&D efforts. Effective research and development efforts can support future growth in sales and profits.

- NDR’s measure of market sentiment (investor optimism or pessimism) is at a level which historically has been unfavorable for DELL. Key turning points occur in the stock market when investor sentiment reaches optimistic or pessimistic extremes. Ned Davis Research analysis has shown that adjusting sentiment for the monetary environment enhances the reliability of this information.

- DELL’s volume action, as measured by indicators applied to trading volume, is currently showing weakness. Volume indicators are used to confirm the strength of price trends. Lack of confirmation may warn of a reversal."

Remember, sticking to a DELL strategy means focusing on their performance in China and India and on improving their margins. Buy the stock only when it comes to you.

DELL 1-yr chart:

DELL 1-yr chart