“The exact reasons you didn’t want to own Dell stock over the past couples years are turning into the exact reason you do want to own Dell over the next couple, in our opinion,” writes Craig. Dell’s 40% of sales in the U.S. have been a weakness for the company, points out Craig, as U.S. personal computer sales have trailed other parts of the world (Hewlett-Packard (NYSE:HPQ) gets only 30% of sales from the U.S.).
But that’s poised to change as the U.S. market improves: “We believe the U.S. PC market is poised to turn around as evidenced by what appears to be bottoming GDP growth and 1Q07 PC unit growth, after two quarters of decline.” Dell has only a modest 15% share of consumer PCs, notes Craig, versus HP’s 50% or greater, but he thinks that will change and that Dell will gain share through recent deals to expand its retail presence, such as with Wal-Mart (NYSE:WMT), which was rolled-out in June.
In general, Craig expects Dell to “aggressively” get into retail. Lastly, 60% of Dell sales are desktops, which are trailing notebook computers in unit volume growth, and Craig thinks Dell will go deeper into notebooks to fix that problem, such as with its recent unveiling of multiple color options for its laptops.
Other pluses for the stock include the company’s recent announcement it’s going to cut 10% of its workforce, which will add 23 cents in profit annually, says Craig. He hopes, though, that the company will aggressively buyback shares starting in the third fiscal quarter of its 2008 fiscal year (the October/November-ending quarter), to the tune of at least $1 billion per quarter. He notes that Dell previously had a practice of buying back as much as $1.7 billion per quarter.
Craig’s $35 price target is based on a P/E multiple of 21x next year’s (fiscal 2009) earnings per share of $1.36. That’s a “lofty” multiple, he concedes, but contends that expectations are probably too low for the company’s profitability if it can make progress from currently depressed levels of profitability. Risks that Craig notes are that component prices for chips and other PC ingredients, which are low currently, could rise substantially, eroding gross profit. Also, the technology known as “virtualization,” which allows IT shops to consolidate their data centers onto fewer individual computers, could crimp Dell’s sales to corporations.