PCs languish, but Dell leaps ahead
Personal computers are now a commodity business. But PC giant Dell’s near-manic focus on efficiency and moves into new products mean there’s more growth ahead.
By Jon D. Markman
The personal computer, which brought us thousands of percentage points of returns in the 1990s, is absolutely, positively dead as an investment theme. In case you hadn’t noticed.
But that doesn’t mean there is no reason to consider owning shares of premier direct-sales computer maker DELL, which have been stuck in a holding pattern for a year.
Did I really say Dell? Just the mention of the single syllable elicits a variety of reactions from seasoned investors.
In the mid-1990s, when many came into the market, it was nothing for the stock to rise $5 a day, well before the era of the neurotic Internet stock. Its earnings-report weeks were exciting events. Shares rose 92,000% from 1990 through 1999. It made ordinary people fortunes, launching thousands of BMW sales and first-home down payments.
If you’ve owned Dell for the past three years, on the other hand, you’re probably sick of it. In a double-blind test, you couldn’t distinguish its price chart from that of an electric utility. It’s flatter than day-old Pepsi.
The future will be different: Not as great as the ‘90s, but not as bad as the past 36 months, either. All that boring, sideways trading between $31 and $37 recently is probably accumulation, as long-term players regularly come into the stock at the bottom of the channel in anticipation of a new cycle of success. The company is unmooring from its roots as a PC vendor and moving up the value chain into high-demand enterprise storage and high-fashion consumer electronics.
Growth at 4 times U.S. GDP is fantastic
It’s not like the personal computer is disappearing, though: Globally, shipments are expected to reach 185 million units in 2004, fulfilling the wildest expectations of PC bulls of the early 1990s. Analysts at Gartner Group may have recently cut their PC sales growth estimates for the year to 12.6% from 13.4% in the wake of soft results witnessed throughout the economy, but let’s get real: Double-digit growth, at four times the rate of U.S. GDP growth, is fantastic. The prosperous soft-drink industry is happy to post 5% annual growth. The beer industry grows at about a 1% pace.
The problem is that the PC business has become what the skeptics of the 1990s forecast: Cyclical. Which means that there will be prosperous years and lousy years. For investors, that means you need to buy on troughs and sell on crests. PCs have become much like the automobile industry, which is a replacement business. You don’t buy a new PC anymore because you are tantalized by its awesome new speed or graphics capabilities, but because you need one for some reason, such as a business or family expansion.
Bret Rekas, a Minneapolis-based hedge fund manager specializing in technology stocks, said he has a 5-year-old laptop on his desk running Windows 2000. Sure, it’s old, he said. But the father of brand-new twins said that if he’s going to drop $2,000 on something, it’ll be on a vacation for him and his wife -- not a thinner, slightly faster computer.
The replacement cycle works
What draws Rekas and his ilk back to PCs? The replacement cycle. Gartner analyst George Shiffler says the buildup of older PCs in the installed base at homes and businesses around the country is exerting a strong pressure. They weren’t built to last forever. The operating system, made by Microsoft (MSFT) publisher of this site, wears down, and the machines slow to a crawl. They will be replaced because they start acting like old clunker cars. It’s one thing if they don’t look like much, but when they don’t work well anymore even to surf the Web, it’s time to pony up for a new model. Particularly one with an awesome new graphics card.
Most PCs are bought by companies, however, and the bosses have been stingy. U.S. corporations have built up a huge cash hoard in the past couple of years, probably in anticipation of another major economic turndown akin to the ones that afflicted the country amid the oil shock of the mid-1970s, or the mild recessions of 1990, 1994 and 2001.
But if energy prices hold fast and developing-world consumer demand continues at the current or slightly slower pace, world economic growth could surprise investors in 2005. The Economic Cycle Research Institute’s weekly leading index, which has correctly forecast every recent slowdown and recession, has pulled out of its 2004 nosedive in the past few weeks and stabilized. The index hasn’t turned back up yet, but, on ECRI’s 30-year chart, the abrupt change of direction looks eerily like ones that occurred at the end of 1982 and 1994, just before sharp changes in the nation’s economic fortunes.
The Wal-Mart of PC makers
As information-technology spending turns up a bit itself, Dell has probably better prepared itself to succeed than any of its vendors, such as Microsoft, Intel (INTC), Nvidia (NVDA), and Western Digital (WDC). That’s because Dell is a lot like Wal-Mart (WMT): It’s a dominant low-overhead retailer with the power to grind down vendor prices to the bone to expand its own margins. Component makers’ shares would rise sharply from today’s extremely depressed levels in the event of anticipation of an industrywide upturn, but Dell is more likely to be able to sustain a move.
In 10 years, after the next peak, dozens of little vendors will merge or get wiped out. Dell, however, will survive. That’s what longer-term investors will focus on.
Helping Dell to thrive is its proven ability to push into the enterprise, or corporate, space and offer mid-range product functionality at low-range prices -- undercutting the likes of Hewlett-Packard (HPQ) and IBM to gain market share. What it has done in PCs it is now doing in storage, printers and IT management/deployment services, which are the fastest-growing segments of technology.
Partnering with industry goliath EMC to provide top-notch network storage systems on a direct-sales basis, indeed, has been a masterstroke, generating new higher-margin sales for Dell that extend well beyond the PC. And on Sept. 1, Dell launched three aggressively priced color laser printers based on the technology of partners, including a high-end model that does 25 pages per minute in color for $999 -- half the price of similar functionality from HP. Moreover, its toner pricing is 0.6 cents per page for black and white and 6.9 cents per page for color -- 67% and 28%, respectively, below HP pricing, according to analyst Shannon Cross of Cross Research LLC.
The numbers: Very impressive
Dell sales (totaling $45 billion in the past 12 months) are still growing at an impressive pace, about 19% a year, while earnings ($3 billion in the past 12 months) are still growing at a 19% to 25% annual rate. Cash flow, slightly less awesome than a few years ago, is still ridiculous at better than $3.6 billion a year. The next big goal, according to the company: $60 billion in sales by 2006 at the same level of profitability.
Founder and chairman Michael Dell this summer gave up the chief-executive reins to Kevin Rollins. Essentially, though, they run the company together now as they always did -- focusing much more on perfecting efficient manufacturing and distribution practices than on innovative technology. In a price-conscious world of commodity products, that is bound to be a winning formula for many years to come.
The problem with Dell’s share price has not been the business, it’s been a contraction of its price-earnings multiple to account for slightly lower expectations. That may be almost complete now, so if you’re patient, you’re more likely to see that the share price will follow earnings growth over the next year and beyond.
Fine Print
Think it's an overstatement to say Dell trades like a utility? Overlay the two-year charts of Dell and Wisconsin Energy (WEC) and you'll see they are virtually identical. Check the overlay here. moneycentral.msn.com (Please note the chart data is Wisconsin Energy's. The company name is incorrectly listed as Wisconsin Electric.) . . . Since January 2000, Dell has suffered the least of the six major Nasdaq 100 tech leaders at the time: Dell, -31%; Intel, -49%; Microsoft, -53%; Oracle (ORCL, news, msgs) and Cisco Systems (CSCO), both down 63%; and Sun Microsystems (SUNW), -90%. . . . The only Nasdaq tech mega-cap with a positive return in the new millennium is eBay (EBAY), up 190%. Security software maker Symantec (SYMC), less than a third the size of eBay at $16 billion in market value, is up 270% in the past 4 1/2 years, beating them all. In the interest of full disclosure, I should note that I have Dell desktops at my home and office. When it comes to laptops, however, I’m a diehard Toshiba fan. . . . To learn more about Dell products, visit its Web site. If you haven’t shopped for a PC lately, you may not realize how much you can get for under $1,000 now. A Dimension 8400 with a 3-Ghz Pentium 4 processor, 80 gigabytes of hard disk space, 512 megs of RAM, a DVD player and a 17-inch LCD monitor clocks in at $949, (after rebate). So far, its small consumer electronics pieces haven’t dazzled, but the second generation will be better. Here’s a link to its iPod-rival, the Dell DJ 15, which has a nice price point of $199 and integrates well with your PC -- but lacks the iPod’s cool ergonomics. Dell-branded flat-screen TVs are well-priced. Check out the line here. . . . The company has a nice archive of its annual reports online. Thanks for the many e-mails following my request for two-sentence trading strategies in my last column. I’ll list and explore many of them in a column later in the month.
moneycentral.msn.com
Jon D. Markman is publisher of StockTactics Advisor, an independent weekly investment newsletter, as well as senior strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jon.markman@gmail.com; put COMMENT in the subject line. At the time of publication, Markman controlled positions in the following stocks mentioned in this article: Dell, Microsoft. |
