analyst notes KEY POINTS:
1. Q4 earnings of $0.42 versus $0.31 modestly exceeded our $0.41
forecast.
2. Q4 highlights include strong unit growth, a modest rise in ASP's,
a further increase in enterprise systems and strong asset management.
3. Despite issues related to channel inventories, ASP trends and
Asia, management cautiously optimistic about future and feels
comfortable with future forecasts.
4. We believe favorable trends evident in Q4 will help calm investor
concerns and favorably impact the shares' P/E.
5. Buy (1) rating reiterated with a 6-12 month target price of $40-45.
Q4 HIGHLIGHTS
Some of the key points we took away from the earnings report and
conference call include the following:
-- While reported sales of $7.32 billion were modestly below our $7.4 billion forecast, foreign currency exchange negatively impacted sales by about $300 million (or five points of growth), more than making up for the difference and translating into healthy sales momentum on a constant currency basis.
-- Overall unit growth in the quarter was 44% representing growth of
about triple the overall market. In 1998, we expect that we will see a more pronounced consolidation in the market than in prior years, driven by the manufacturing and distribution re-engineering programs of the major vendors and Intel's less dominant position in the industry. In this environment, we believe certain well-positioned vendors, such as Compaq, will be able to grow their units 2-3X the overall market. This is important because in today's environment, scale of size benefits(especially from component vendors) are increasingly important to PC vendor profitability.
-- The continued healthy trends in North America (up 52% in units) and the recovery in Europe (also up 52% in units), helped offset the
slowdown in Asia Pacific and Japan (where units were down 1% and 16%
respectively). In 1998, we believe that ongoing strength in North
America and especially Europe, which represented about 35% of sales in
the quarter, should help offset the risk to the 6-7% of the sales base
derived from both markets in the Far East.
-- The major reason for the increase in gross margins was tied to the
strong growth in enterprise system sales (servers, workstations,
networking and options), which now constitute 37% of sales versus 33% in
the September quarter. This shows further progress toward the company's
goal of 50% of revenues from this area by 2000. This large market share
is a major reason why Compaq's overall sales growth should continue to
exceed that of the PC market. Moreover, the strength in enterprise
system sales was the main driver of the slight sequential increase in
ASPs. Thus, we believe that this gives Compaq the unique ability to
drive down ASPs at the low end of the market (and really grow market
share) without a major disruption to its financial model. We believe
that the most important consequence of a greater mix of enterprise sales
and earnings is a higher P/E multiple.
-- Regarding the issue of inventories in the distribution channel,
Compaq backed away from giving specific numbers in each geography (we
believe a smart move). However, while they failed to meet their
aggressive 2-3 week worldwide goal (which had been expected), they have
made progress from last year - notable given that last year's
inventories were double the current number of weeks. More importantly,
despite the widespread reports of special incentives to the major
channel resellers in December (which we hear are selling through),
management believes that overall inventory levels are in good shape and
will not have a negative impact on results in the March quarter. Also,
now that investor expectations of the timing of the company's
manufacturing and distribution re-engineering plans have been properly
recalibrated ( to mid 1998ish), the benefits to margins and the
company's P/E multiple have yet to accrue.
-- Relative to the balance sheet, it appears that Compaq now fully
understands (and is executing well) today's new "earns x turns" business
model in the PC market, placing as much emphasis on managing the balance
sheet as the income statement. Favorable signs include an exit rate in
the quarter of inventory turns approximating 14x (versus about 10x in
the September period) and a further improvement in DSOs to about 35
days. This helped drive a further increase in cash to $6.76 billion
from $5.96 billion last quarter and $4.0 billion a year earlier. As a
result of these favorable trends, ROIC increased to 90% (138% excluding
Tandem) versus 49% a year ago. The large cash position gives Compaq a
good deal of financial flexibility and can be used to make an anti-
dilutive acquisition, increase its dividend or buy back its own shares
(which we believe it can begin to do in the first half of 1998). We
note that Tandem was once again additive to earnings last quarter,
illustrating management's success in making positive acquisitions. |
