Dell's Competitive Moves Make Sense

Dell, Inc. (DELL) was the last of the major tech companies to report earnings, and the results for the period ended Aug. 1 were less than spectacular. Dell’s net income slipped 17% from the same period a year ago. In addition, earnings shrank from $746 million or 32 cents per share to $616 million or 31 cents per share. Sales slumped in the U.S. and Western Europe, as macroeconomic concerns hurt consumer spending.

Of further concern was the relatively large decline in gross margins from 18.4% to 17.2%. Dell was attempting to gain market share in emerging markets in order to prevent its biggest rival HP (HPQ) from getting a foothold. In order to accomplish its goals overseas and increase sales domestically, the company was forced to aggressively lower prices. The result was more sales—revenue was up 11%—but with less bang for each buck. Not surprisingly, Dell’s stock took a beating Friday— shares were down more than 12% on heavy trading volume.

The earnings results were disappointing to us as well but not all of the data was bad. For example, Dell’s initiative to cut costs is starting to yield results; the company reported operating expenses that were lower than in any of Dell’s last six quarters. One of the most widely known ways in which DELL cut costs is by reducing its headcount by nearly 9,000 workers. The company has also driven down supply chain prices and its new line of laptop computers is said to have substantially reduced production costs, which should have a positive effect on margins going forward.

There is little doubt these days that the global economy is in a slowdown, but it is foolish to think that opportunities do not exist outside the U.S. in other developed economies. For computer makers, India and China will be major export markets for years to come, simply because of sheer population size combined with the ever-more-affordable price of technology. Even if the breakneck growth of these economies may be cooling, there is no doubt that they will continue to grow for the foreseeable future. For Dell, we think it makes sense to drop prices now—even if it squeezes margins—in order to better compete with the likes of HP and Lenovo (LNVGY.PK).

Ockham Research has been bullish on Dell stock for some time, but the stock has yet to find a catalyst to push it back to more historically normal price levels. Including Friday’s drubbing, DELL is down more than 21% over the last year. However, while it may take a long-term perspective, we believe that the underlying value in the Dell will not go unnoticed forever. We studied what the market has historically been willing to pay for Dell on a cash and sales basis and the shares look undervalued.

Traditionally, the market has been willing to pay between 1.36x and 2.42x sales per share for Dell, but currently that metric has fallen to .85x (before Friday’s drop). Likewise, Dell is 49% below the historical average level of price-to-cash flow, again prior to Friday’s market action. There is compelling value in Dell at current levels—even before the drastic price drop of Friday. Ockham rates Dell a Buy for long-term investors.

Comments

[mollytjm:]

Dell closed it's mall kiosks which means it reduced its footprint and visibility. in the King of Prussia Mall, (PA) one of the biggest in the country, Dell is gone and the Apple store reigns supreme and alone. so i don't quite get the title of the article. Dell retreated because of financial concerns, not as a marketing move. Dell lost customer loyalty very quickly when they outsourced their tech support to the lowest bidder. everyone i know with Dells, had loved Dell, until they had to call tech support and got none. Dell is trying to fix this, but don't you think they have lost too much ground, not just to Apple, but to others? Dell might be able to find a low-end niche...but right now, it looks like that's all that's left. i hold APPL long term, but i'm nervous about doing that with DELL. APPL has gone up and down too, but as a company it is more financially secure and they obviously have vision and innovation on their side, plus a better reputation among customers: the moat. There's room for other players in this game, but DELL has to fix a lot and i'm not sure they are capable.

2008 Sep 01 10:14 AM

[Oh Blah Dee...:]

Dell is trying to be the leader in price, when many computer buyers want more of an EXPERIENCE using their computer.

After people have computers for many years, they want more excitement during their daily lives, and Dell does NOT provide it with Dell computers.

Price will always have importance, however, people will pay more for enjoyment, and that is what Apple brings to the market.

2008 Sep 01 11:46 AM

[Stephen Ros...:]

Dell has fallen down on the job with its terrible servicing. I've always owned Dells but have gotten frustrated with dealing with service issues in which I am always interacting with people who don't speak English and who know nothing about computers!

2008 Sep 01 01:30 PM

[mkreisel:]

They will all go down. But as the lowest cost provider, DELL should suffer less than other high-fliers.

AAPL, with hordes of retail suckers, will fall down the hardest.

2008 Sep 01 07:21 PM

[Chakkar:]

This company is trying to figure out whether it is just a computer assembler (it's *not* a manufacturer) or a services company. Let's face it: services revenues have fat margins and can drive profits a lot faster if Dell can capitalise on the opportunity. Easier said than done. Running a services business is a lot more difficult than assembling computers cheaply. Unlike IBM, Dell has never had a software development business so it has to learn a completely new culture.

More broadly, over the long term, I don't expect any advanced-economy companies to be selling computers; margins are too low. Emerging-market companies will probably be hungrier for those same margins as they carry far more marginal value. After all this branding across the world, white box or local brands make up close to half the market. This industry is headed for lower margins.

Then, we have the problem of e-waste. Companies like Dell should also set up [Dell.org] websites because cleaning its e-waste is a break-even business at best. Think it's not an issue? Just wait for some Westerners to get seriously ill from drinking water that was contaminated from e-waste; they were visiting a developing country that receives all this e-waste from N America and W Europe. Lawyers are waiting for it, I'm sure.

Long term, Dell is stuck between $15 and $30, the high end because it starts to pay a sustainable (with inflation) dividend.

2008 Sep 01 11:07 PM

[Shiv Kapoor:]

Agree with the author. People are crazy, they buy HPQ at $45+ and shun it at $18 (at which time they bought Dell at $40+). Now they shun Dell. If you are working un-levered and can wait, go for Dell; at some point over the next 5 years you can be virtually sure you will double from here. With HPQ you will not. That is the beauty of turn around stories - over confidence breeds arrogance and failure breeds humility and success; Dell is almost there.

2008 Sep 02 09:01 AM

[User 254539:]

Dell as a stock is very cheap. It has $9.5 billion cash and less than $2 billion of debt. Total shares outstanding is about 2 billion, translating into $3.75 of cash per share (minus debt). The reduced analysts' future earning prediction is $1.78/sh. The effective PE (minus cash) is only 9.6 (at the closing price of $20.83). You have to go to mid-1990s to see such a low PE for Dell.

2008 Sep 02 04:46 PM