SSB writes a very bullish report;
then ignores all the strength;
then gives a neutral rating.
Go figure... No wonder a sane person can't be an analyst.
Salomon Smith Barney
Wednesday, May 19, 1999
--SUMMARY:--Dell Computer--PCs
*Dell reported 1Q00 revenue and EPS in line with our estimates yesterday
after the close. Revenue of $5.54B (+7% qtr/qtr and 40% yr/yr) was just
slightly higher than our estimate of $5.49B. EPS of $0.16 were exactly
in line with our estimate and the Street consensus.
*Gross margin declined 90 basis points qtr/qtr from 22.4% to 21.5%. The
gross margin decline was offset by a reduction in SG&A percentage,
leaving operating margins flat with C1997 levels.
*While we agree that the Internet will allow Dell to increasingly scale
operating expenses with revenue over time, we were surprised at the
magnitude of this quarter's gross margin and op ex margin declines. We
view this as a sign of increasing competitive pressure.
*Maintain Neutral rating and $30 target; no change in EPS estimates.
--EARNINGS:-----------------------------------------------------------------
FYE 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year
Actual 01/99 EPS $0.11A $0.13A $0.14E $0.16E $0.53A
Previous 01/00 EPS $0.16E $0.17E $0.19E $0.20E $0.72E
Current 01/00 EPS $0.16A $0.17E $0.19E $0.20E $0.72E
Previous 01/01 EPS $0.20E $0.21E $0.23E $0.25E $0.89E
Current 01/01 EPS $0.20E $0.21E $0.23E $0.25E $0.89E
Previous 01/02 EPS $N/A $N/A $N/A $N/A $N/A
Current 01/02 EPS $N/A $N/A $N/A $N/A $N/A
Footnotes: EPS are fully diluted.
--FUNDAMENTALS:-------------------------------------------------------------
Current Rank........:3-H Price 05/18/99......:$44.06
Prior Rank..........: Target Price........:$30.00
P/E 01/00...........:61.2X 52 Wk Price Range...:54.31 - 19.57
P/E 01/01...........:49.5X Proj. 5yr EPS Grth..:25.0%
Return on Equity 99.:89.00% BookValue...........:$1.29
LT Debt-to-Capital..:N/A% Dividend............:$N/A
Revenue 2000........:$24329.00 mil Yield...............:N/A%
Shares Outstanding..:2784.00 mil Convertible.........:No
Mkt. Capitalization.:$122663.04 mil Hedge Clause(s).....:
Comments............:
--OPINION:------------------------------------------------------------------
REVIEW OF QUARTERLY RESULTS:
REVENUE
Revenue of $5.54B (up 7% qtr/qtr and 41% yr/yr) was $50M higher than our
estimate of $5.49B (up 6% qtr/qtr and 40% yr/yr) primarily due to
slightly higher than expected unit shipments (2.40M versus our estimate
of $2.36M). The slight upside to unit shipments appears to be
attributable to stronger than expected results in North America and Asia
Pacific (most likely China).
---------------------------------------------------------------------
Summary of Results Actual Expected Year Ago Prior Quarter
---------------------------------------------------------------------
Revenue $5,537,000 $5,486,177 $3,920,000 $5,173,000
Rev Growth (Yr/Yr) 41% 40% 51% 38%
Gross Margin 21.5% 22.3% 22.3% 22.4%
SG&A $508,000 $532,159 $388,000 $492,000
Net Income $434,000 $431,093 $305,000 $425,000
Diluted EPS $0.16 $0.16 $0.11 $0.15
---------------------------------------------------------------------
---------------------------------------------------------------------
Yr to Yr Unit Growth Actual Expected Prior Qtr 6 Qtr Range
---------------------------------------------------------------------
Server 51% 51% 9% 9%-135%
Workstation* 100% 125% 133% n/a
Desktop 49% 45% 49% 49%-62%
Portable 64% 68% 80% 64%-141%
---------------------------------------------------------------------
Total 52% 50% 55% 52%-74%
---------------------------------------------------------------------
* Dell did not sell any workstations prior to 3Q98
---------------------------------------------------------------------
Asset Management Metrics Actual Expected Prior Qtr
---------------------------------------------------------------------
Inventory Turns 62 52 58
Days of Inventory 5.9 7.0 6.0
Days Sales Outstanding 35.0 34.0 37.5
Days of Payables 52.9 50.0 53.6
Cash Conversion Cycle -12 -9 -10
---------------------------------------------------------------------
---------------------------------------------------------------------
ASP Actual Expected Year Ago Prior Quarter
---------------------------------------------------------------------
Overall $2,307 $2,323 $2,485 $2,343
Notebook $2,890 $2,900 $3,397 $2,910
Desktop $1,642 $1,725 $1,920 $1,740
---------------------------------------------------------------------
On a geographic basis, revenue growth was 45% yr/yr in the Americas, 29%
yr/yr in Europe and 48% yr/yr in Asia. While 1Q00 revenue growth in the
Americas and Asia represented an acceleration over prior quarters (in the
Americas, 1Q00 growth was close to 3Q99 levels), growth in Europe
decelerated from last quarter's 40% growth and last year's 58% growth.
Management stated that attach rates and the transactional (consumer)
business could have been stronger in certain European country markets,
and that this will be an area of focus going forward.
---------------------------------------------------------------------
Yr to Yr Revenue Growth Current Quarter Prior Quarter
---------------------------------------------------------------------
North America 45% 39%
Europe 29% 40%
Asia 48% 30%
Total 41% 38%
---------------------------------------------------------------------
GROSS MARGIN
Dell management had warned the Street prior to this quarter that it would
take advantage of operating leverage to lower gross margin and thereby
drive revenue growth and market share gains. However, this quarter's
reported gross margin was 21.5%, down 90 basis points sequentially and 80
basis points yr/yr. This was much sharper decline than we had expected
(our estimate was 22.3%).
Recall that Dell fell approximately $100 million short of consensus
revenue expectations last quarter, admitting that it had not priced
aggressively enough. In essence, Dell allowed its relative price
advantage to narrow and lost business as a result. This quarter, Dell
lowered gross margin to reclaim its cost advantage.
Bulls will say that the worst is behind Dell, and that having reclaimed
its relative cost advantage and simultaneously reduced operating
expenses, the company should be well positioned to meet both top and
bottom line expectations. We note, however, that this is the first
quarter that we can remember when Dell was forced to reduce total
corporate gross margins in order to maintain a price advantage. In the
past, Dell was able to use positive mix shifts toward higher margin
servers, notebooks and workstations to offset more competitive desktop
pricing conditions. The same positive mix shift is underway, and yet Dell
is now being forced to lower overall blended gross margins to maintain a
price advantage. This is a clear signal, in our view, that Dell's
competitors have made progress toward closing the pricing gap.
OPERATING EXPENSES
The 90 basis point sequential decline in gross margin was partially
offset by a 34 basis point decline in operating expenses as a percent of
sales. Obviously, the company's operating margin declined sequentially
(from 11.5% to 10.8%), but operating margin was relatively flat year over
year (10.8% versus 10.9% one year ago).
The decline in operating expenses reflected a sharp decrease in new hires
during the quarter. While Dell reported 1,700 new permanent hires during
the quarter, some 1,100 of these employees were already working for Dell
last quarter in a temporary capacity; Dell merely brought them on board
as permanent workers this quarter. Net, net, new hires contributing to
the company's SG&A for the first time amounted to just 600 this quarter,
versus 1,100, 2,600, 2,900 and 1,700 during the prior four quarters.
Aside from Dell's aggressive hiring rate last year, the single most
important factor allowing the company to scale operating expenses this
quarter was the Internet. Dell managers in all areas of the business are
aggressively steering customers to the Internet for sales, product
information and technical support. It is difficult to quantify how much
of this quarter's operating leverage was related to a shift toward the
Internet, but Dell states that a full 30% of sales ($18M per day) are now
taking place via the Internet.
EARNINGS PER SHARE
On balance, earnings per share of $0.16 were exactly in line with our
estimate and the consensus.
GUIDANCE
Dell CFO Tom Meredith told analysts that the positive and negative
factors affecting gross margin fell "fairly well balanced" at this time.
He did, however, remark that a continued shift toward the Internet should
give the company additional room to scale operating expenses during the
coming 12-18 months. Net, net, Meredith appeared to signal that he did
not perceive the immediate need for further gross margin reductions in
order to achieve Dell's top line goals.
Meredith also remarked that he would not be surprised if Dell's operating
and net margins hovered around the current quarter's levels. Without any
changes in our revenue assumptions, this implies no changes to F2000 or
F2001 earnings estimates either.
We do not expect significant upward or downward revisions to Wall
Street's F2000 or F2001 earnings estimates today, and we are not changing
our estimates either.
OUR VIEW
We maintain our Neutral rating on Dell shares. While we believe that
there will be an inflection point sometime this year when incremental
initiatives (China, consumer, SMB, sub-$1,000, high-end server, storage,
new services) ramp sufficiently to mitigate the risk of an earnings
shortfall, we believe there is significant earnings risk for at least one
more quarter based on 1) increasing competition in Dell's core large
accounts customer segment, and 2) continued declines in average selling
prices due to the shift in mix toward low-end systems.
Maintain Neutral rating and $30 price target.
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