Morningstar Analysis:
Analyst: Jeremy Lopez | Posted: 02-24-00
The Bulls Say
? Compaq Computer is showing signs of improving its profitability. In the fourth quarter, for example, overhead costs decreased to 15% of sales from 18% in the second quarter. Moreover, its struggling corporate-PC unit cut its losses in half from the third to the fourth quarter.
? The company is finally making a serious transition into a direct-sales model. The recent purchase of distribution assets from Inacom ICO should hasten this transition.
? Not all the company's divisions are struggling. Compaq's consumer-PC unit is performing fairly well, and half of the firm's sales come from its Enterprise segment, which includes servers and storage products. That segment has decent margins and growth prospects.
? The release of Microsoft's MSFT Windows 2000 should provide some decent growth opportunities for Compaq, as customers tend to upgrade hardware at the same time they upgrade to a new operating system.
The Bears Say
? Competitors such as Dell Computer DELL have been cleaning Compaq's clock. The company is steadily losing market share across the board, both domestically and abroad. Its lack of momentum isn't likely to slow overnight, either.
? Compaq's corporate-PC segment is struggling. A big reason for the segment's demise is rooted in its high cost structure and lack of a direct-sales strategy. Because Compaq has been slow to adapt, the segment's margins have lagged those of its more nimble peers. To its credit, Compaq is giving its corporate segment a face-lift, but the transition could easily take longer than expected.
? It's a little early to assume Compaq's growth and profits are fully on the road to recovery.
Analysis | 02-24-00
Stock price as of analysis date: $25.18
Because expectations are so low, Compaq Computer's shares seem ripe for a turnaround.
For good reason, the company has been in Wall Street's doghouse over the past year. But with expectations as low as they are, Compaq's shares are worth a look. Most still think that the firm won't come anywhere close to the goals it has set for itself. Therefore, if the company can show even modest progress in 2000, the stage seems to be set for a positive surprise.
The spotlight is clearly on Compaq's woeful corporate-PC segment, which in 1999 accounted for a third of the firm's sales. Managment hopes to have the segment selling 60% of its PCs directly to customers by the end of the year. But given the sheer complexity of such a change, this goal looks like a long shot. Even if Compaq can manage to sell only 30% of its corporate PCs directly, however, the unit should be able to marginally contribute to profits in 2000.
With modest profitability coming from Compaq's corporate unit, it shouldn't be too difficult for the company to improve its overall operating margins to about 7%. Although operating margins of 7% would lag those of Dell Computer DELL, they would be much better than Compaq's fourth-quarter operating margin of 4%.
Moreover, the outlook for revenue growth isn't all that bad. Based on the company's prospects with the release of Windows 2000, decent opportunities for server and storage growth, and the success the company has had in the consumer-PC market, a 12% growth rate in the next few years seems very reasonable.
Assuming 12% growth and operating margins of about 7%, Compaq's profits should more than triple in 2000, a big improvement over last year. Yet consensus estimates are even lower than these modest improvements assume. At about 23 times next year's earnings, Compaq therefore appears to be one of the few decent and reasonably priced investment opportunities in the technology sector. |
