Dell (DELL) looks undervalued, with significant upward potential. Let me explain why I believe this to be the case.
- At the time of this writing, Dell is trading at ~$16.60 per share, representing ~8.8x trailing P/E, and ~6.5x EV/EBIT.
- This kind of valuation is normally seen in a company with zero to negative growth
- However, Dell's strategic repositioning has shown signs of success with solid, stable performance over the past few years.
- For example, in FY12, Dell's gross margin jumped to 22.3% (highest in 13 years!) from 18.5%, and its EPS jumped to $1.88 from $1.35 (see chart below).
- In addition, Dell has been buying back shares at a very attractive rate (see chart below).
- I believe this trend is likely to continue (although the rate of growth may not be as stellar).
- Downside protection: Dell has ~$8 in cash + short-term investments per share, and is generating $1.88 of high-quality net profit per share.
Strategy Shift
If you go back to say, 2004-2005, this is what the company had to say about its business strategy (emphasis added):
Dell's business strategy combines its direct customer model with a highly efficient manufacturing and supply chain management organization and an emphasis on standards-based technologies. This strategy enables Dell to provide customers with superior value; high-quality, relevant technology; customized systems; superior service and support; and products and services that are easy to buy and use. The key tenets of Dell's business strategy are: … Dell is the low-cost leader… Non-proprietary standards-based technologies deliver the best value to customers… [Source: Dell's FY05 10-K]
Dell has followed this strategy for a while, and we all know what happened. Revenue increased but margins decreased, leading to a period of poor earnings and shrinking book value. Likewise, the stock got pounded to the ground, and Ben Curtis (aka "Dell Dude") became a guy nobody likes to hang around with.
By 2006-2007, you can tell that the company has done some soul searching, and has changed its mind on a number of strategic issues:
Our business strategy is evolving as we combine our direct customer model with relevant technologies and solutions, highly efficient manufacturing and logistics, and new distribution channels to reach commercial customers and individual consumers around the world. Using this strategy, we strive to provide the best possible customer experience by offering superior value; high-quality, relevant technology; customized systems; superior service and support; and differentiated products and services that are easy to buy and use. Historically, our growth has been driven organically from our core businesses. Recently, we have begun to pursue a targeted acquisition strategy designed to augment areas of our business to gain more access to products, services, and technology that our customers value…
By 2009-2010:
We are focused on improving our core business, shifting our portfolio to higher-margin and recurring revenue streams over time, and maintaining a balance of liquidity, profitability, and growth. We consistently focus on generating strong cash flow returns, allowing us to expand our capabilities and acquire new ones…
And finally, by 2011-2012:
A few years ago, we initiated a broad transformation of the company to become an end-to-end technology solutions company… Since the beginning of Fiscal 2011, we have acquired more than ten companies whose offerings and intellectual property enhance our solutions business...
Performance
Dell has shown clear, stable progress towards its strategic goals. For example, from FY08 to FY12, Dell has steadily increased the % of revenue coming from services to 19.6% from 12.1%. That is a good thing, since services have much higher gross margins. With a 22.3% gross margin in FY12, this is the highest in 13 years -- FY99 was higher at 22.5%! Other notes I jotted down while reading:
- Gross, operating, and net margins all improved from FY10 to FY12
- At the same time, Dell has significantly increased R&D (1% of revenue in FY11 to 1.5% in FY12), increased headcounts, made the necessary capital investments for growth, while incurring additional costs associated with its strategic transformation (i.e. Dell's growth is sustainable)
- Dell seem to be successfully broadening its product offerings, and its acquisitions seem to paying off
- Very nice stock buyback program that more than offset dilution; nice buildup in book value from FY08 to FY12
Note that this is an initial analysis of the company. However, the points above should at least warrant further investigation. Feel free to agree or disagree.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in DELL over the next 72 hours.
