Barront's may 21. pls. take comments on the other thread. news only.
Can Dell Really Do No Wrong?
May 21, 1998
interactive.wsj.com
By Lisa R. Goldbaum
In recent years, Dell Computer has been the kind of stock investors pray for.
Surpassing stock market stalwarts like Intel, Microsoft, Cisco Systems and
Coca-Cola, Dell's share price has tripled from the roughly $30 at which it traded
a year ago -- and in a relatively mature, price-sensitive industry that's been
ravaged by Asia's economic crisis.
Dell has definitely deserved all the adulation it has gotten. Its made-to-order
strategy has let the company sidestep the inventory logjams plaguing rivals like
Compaq Computer, and it is quickly becoming the industry standard. (In fact,
aping Dell's success, Compaq itself has been attempting to switch to this
method. See Weekday Trader, "A Comeback for Compaq?," May 11.)
Most importantly, Dell has performed where it really counts: the bottom line.
The company has consistently surpassed analysts' rising expectations even as its
peers -- like Hewlett-Packard -- report disappointing earnings. No wonder Dell
appears to walk on water on Wall Street.
But since Dell's better-than-expected earnings release Tuesday -- it beat
analysts' published estimates by two cents a share, but not the alleged "whisper"
estimates -- the stock has actually retreated, falling from about 94 1/2 to
Thursday's closing price of 87 1/2. And though few analysts we spoke with
were willing to voice any doubts whatsoever for the record, questions are
starting to arise about whether Dell can sustain its Teflon-like resistance to
some of the problems plaguing its competitors.
The biggest potential speed bump for Dell is likely to be continuing price erosion
in the computer business. Even in the most recent earnings report, Dell said that
the average selling price for its computers fell 8% to about $2,500. According to
the company, that's largely because prices for the components that go into
personal computers, like semiconductors and memory chips, have been sinking
like a stone.
But other forces are driving down PC
prices as well, like the growing popularity
of computers costing less than $1,000.
Now, Dell doesn't cater to that
bargain-basement end of the market;
instead it focuses on cutting-edge,
higher-margin products that draw more
sophisticated users. But with the
downward pressure on pricing
throughout the industry, consumers
surely will push for more features for
less money, even from Dell.
"Prices are coming down, and people are
starting to demand more value at the lower end," notes Kevin Hause, an analyst
with International Data Corp. "You are seeing erosion of price points, especially
in desktop machines." Indeed, Hause notes that in 1997, computers costing less
than $1,500 represented 30% of machines sold. By 2001, he forecasts, cheaper
computers' share of the market will more than double, to 64% of sales. That
could make it much harder for Dell to keep average selling prices at the
profitable $2,500 level: It simply can't overprice its machines by that much in
cutthroat market.
Moreover, Dell relies on repeat business, basically from more sophisticated
users upgrading to the latest technology. But now we may be approaching the
point where technology geeks looking for the best that money can buy may view
high-end machines as overkill.
Piper Jaffray analyst Ashok Kumar points out that there isn't one big "killer
application" on the horizon that is likely to make computer users rush out to
upgrade their machines. Even Walter S. Mossberg, The Wall Street Journal's
influential personal computing columnist, recently recommended that people buy
the cheaper machines ("The PC Buying Guide," April 23).
All this could start to put pressure on Dell's profit margins, especially if
component prices -- which are currently trending downward but do tend to be
cyclical -- begin to rise again, notes Nick Moore, a portfolio manager with
Orbitex Management in New York.
And though Dell's competitors may be down, they're not necessarily out.
"Competition won't part like the Red Sea," says Kumar.
Of course, the company hasn't been sitting on its hands. Like many of its peers,
Dell has been aggressively bolstering its presence in the corporate market by
selling more servers and workstations. In fact, the enterprise side of the
business has grown rapidly: It now comprises 11% of Dell's revenues, nearly
double the 6% of sales it represented last year, Hause notes. And Dell's
overseas sales, particularly in Europe, are going gangbusters.
Still, the consumer side of the business makes up an overwhelming two-thirds of
Dell's sales. That means that Dell could be in a horserace to see how quickly it
can boost its exposure to less price-sensitive corporate business before price
erosion on the consumer side begins eating away at margins.
And with Dell's stock price at its currently high levels, there isn't much margin
for error, notes Moore. "The stock is priced for perfection," he argues. "You
have to draw a line at what multiple it should have."
In fact the stock does look pricey by some common measures. At Thursday's
close of 87 1/2, the shares change hands at about 46 times the $1.87 per share
analyst project the company will earn in fiscal 1999, ending next January. That's
in line with its expected earnings growth rate of 46%, according to Zacks
Investment Research.
Going farther out, however, it's another story. Dell stock trades at 36 times the
$2.44 analysts think the company will earn in the fiscal year ending January
2000. That's a healthy premium to its projected earnings growth rate of 29% for
that year and the next five years as well, Zacks' estimates say. And investors
seem to be growing somewhat jumpy lately, as the stock fell 4 1/4 Thursday.
Dell Computer is a marvelous company that has fooled the skeptics many times
and surpassed even the wildest expectations of its fans. And it may very well be
too early to say this stock has seen its best days.
But with the very conditions that spawned its success beginning to change, the
risks in Dell may be rising faster than the potential rewards.
And remember: Sooner or later, even great stocks run out of steam. |
