Thread...This article appeared in the Aug 5 Barrons "Weekday Trader" and I don't believe was posted here. Makes for good reading.
Steve
Cheap PCs Aren't Worth the Worry
By RIVKA TADJER
This spring, before everyone started worrying about a bear
market, investors had other concerns in mind -- like the
sub-$1,000 PC.
Some analysts argued that the spread of
cheap, powerful personal computers would
wipe out the profitability of PC
manufacturers and even hurt mighty Intel,
which has become a dominant force by getting people to
"move up" to more advanced PCs with the latest Intel
chips.
Investors promptly sold the stocks that would be hurt most
by this trend, including Compaq Computer, retailer
CompUSA and Intel itself. All three are off their 52-week
highs, as are Gateway and Hewlett Packard (which has had
other problems, too).
But it's looking more and more as if once the busy
back-to-school and Christmas seasons are over, the top
five -- Compaq, Dell Computer, IBM, Hewlett Packard
and Packard Bell, which between them account for half of
all PCs sold worldwide -- will be as healthy as they were
before the first sub-$1,000 PC came into existence. They
may even wind up to be stronger companies once
streamlined inventory management, online sales and
product and service diversification plans go into full
swing.
In fact, sales of sub-$1,000 PCs may already have topped
out, according to ZD Market Intelligence, a unit of
Ziff-Davis Publishing. "Sub-$1,000 PCs accounted for
48% of all consumer retail sales in February," says ZDMI
analyst Aaron Goldberg. "But that was the peak; for the
second quarter the number dropped to 40%."
Though Goldberg expects the number to climb again for the
Christmas selling season, he also says come spring of next
year, the percentage may drop again, as high-end buyers
shop based on computing power, not price.
And smart manufacturers are actually finding ways to make
money on $1,000 desktop PCs. "The ASP (average selling
price) of all PCs will continue to drop, but the rate of
decline will slow," says William Milton, analyst at Brown
Brothers Harriman. "By the time the $1,000 PC is the norm,
the production of these PCs will be more efficient and
there will be other computer products manufacturers will
sell as well."
Also, most of the PC makers are diversified companies that
don't stand or fall on PC sales For example, at market
leader Compaq, which has 14% of the world market, "PC
sales still account for [only] 5% to 10% of its total sales
revenue," says Walter Winnitzki, computer analyst at Paine
Webber. "So the $1,000 PC can't have that much effect on
business." PC sales represent a small chunk of IBM and
Hewlett Packard's business, too -- and even Dell gets only
10 percent of total revenue from consumer PCs, Winnitzki
adds.
The cheaper machines have
yet to catch on in the corporate
world, whose PC purchases
amount to twice the dollar
volume of the consumer
market. "The $1,000 PCs are
not penetrating the corporate
market at all yet," says
Winnitzki. ZDMI's Goldberg
says that corporate purchases
of sub-$1,000 PCs, while
growing, remain negligible -- only 5% of all sales by the
end of the second quarter, up from 2% in January 1998.
(Dell officials say they're not even selling sub-$1,000 PCs
to companies because there has been no demand for them.)
Meanwhile, the leading PC makers have responded to
dropping prices by wringing more costs out of their
operations -- making manufacturing more efficient and
thereby stabilizing profit margins. "In general, I've seen
gross profit margins in the PC industry stabilize at roughly
20% over the last 18-24 months, despite falling average
selling prices," says Winnitzki.
In fact, says Winnitzki, "Compaq's lower-priced Presario
carries the highest return, according to Compaq." That
model, the Presario 2254, costs $799, after a $100 rebate.
But inventory costs are next to nothing, because demand is
so high the stores can't keep the machines on their shelves.
"The rate of inventory turns over the last couple of quarters
at Compaq are 100 times for consumer sales," says
Winnitzki. Compaq, which outsources manufacturing to
Taiwan and has streamlined distribution, is trying to move
toward Dell's direct-sales model, so excess inventories
don't weigh down profits. Other PC manufacturers also are
heading in this direction.
But direct sales is just the beginning. PC vendors are trying
to generate repeat business in several ways. According to
ZDMI's Goldberg, more and more consumers are setting up
their own computer networks in their homes. Just as
households bought two cars, four color television sets and
three VCRs to keep everyone happy, parents are buying
Jason and Jennifer their own PCs -- and linking them up
through family networks.
Right now only 1% of households have a network, but that
will climb to 5% to 8% over the next couple of years,
Goldberg says. As of January 1998, the average household
has 1.3 PCs, up only slightly from 1.2 last year. Fifteen
percent of households now have two PCs, and Goldberg
expects that to reach 17% next year. And, of course, the
more PCs people buy, the more peripherals such as
printers, scanners, servers, and network services they'll
purchase as well. Some of those products have higher
margins than PCs do.
Compaq's shares peaked last fall just shy of 40. But as
strong sales of sub-$1,000 PCs caused inventories of
higher-priced machines to build up, the stock price slipped
-- a decline exacerbated by its costly acquisition of Digital
Equipment (see Weekday Trader, "Compaq Makes a Big
Move; Shareholders Cringe," January 26, 1998).
Compaq's stock now hovers at
31, a bit more than 15 times
estimated 1999 earnings of
$1.95 a share -- a nice
discount to its projected
earnings growth rate of 18%
to 20%. Meanwhile, Dell 's
stock is hanging in there at
106, about 10 percent below
its 52-week high of 118 (just
last month). Hewlett Packard,
which has been in the doldrums, actually hit a 52-week low
on August 4, trading at 51 1/8, more than 40% off its
52-week high of 88 in May. Intel has crept back from its
52-week lows of 65 21/32, closing Tuesday around 82,
still well off its high of 102.
These stocks may continue to sag, because of worries about
Asia and the market as a whole. But as the year goes on,
PC manufacturers should fare well -- and the sub-$1,000
PC may turn out to be just a flash in the pan. |
