Fund Managers Are Still Decidedly Un-PC
By K.C. Swanson
Staff Reporter
1/25/01 6:01 PM ET
These days, lots of money managers view PC makers with something like disdain.
The companies aren't increasing sales enough to qualify as growth stocks anymore, and it doesn't help that they've just emerged from one of the nastiest earnings seasons in recent memory. Still, a handful of institutional buyers have made some cautious investments, united by a deep appreciation for cheaper prices and some degree of optimism for a second-half 2001 rebound in the economy.
You'd have to be optimistic to bet on PCs at this point. Consider: The outlook for revenue and earnings growth remains weak, with both consumers and businesses cutting back on spending. Plus, computer makers have already announced plans to push sales with heavy discounting. The two PC stocks that turned up on some skippers' recommended lists -- Compaq (CPQ:NYSE - news) and Dell (DELL:Nasdaq - news) -- won plaudits primarily for their inroads into non-PC, New Tech growth areas such as data storage.
The PC sector's most redeeming feature seems to be its cheap valuations, at least relative to historical norms for the group. "Demand will be spotty for at least another couple of quarters," says Jerome Heppelmann, manager of the PBHG Focused Value fund. "A second-half rebound remains in question. But at these valuations, I think you're seeing investors catch up and want to be there just in case of even modest growth in the second half."
Some institutional investors cautiously suggest PC stocks may have seen their bottoms in December, amid the glut of revenue and earnings cutbacks. "Every PC vendor I can think of preannounced" with fourth-quarter earnings warnings, says Dan Niles, an analyst at Lehman Brothers. He expects to see revenue growth in the low double digits this year.
PCs Are Down
Though 2001 has provided a nice bump, PC makers have had a tough 12 months
Stock YTD Performance 52-Week Performance P/E Ratio (trailing 12 months) Price/Sales (trailing 12 months)
Compaq (CPQ:NYSE - news) 36.2% -34.4% 21.83 0.85
Dell (DELL:Nasdaq - news) 46.9 -41.4 31.14 2.32
Gateway (GTW:NYSE - news) 31.7 -61.8 22.80 0.73
Hewlett-Packard (HWP:NYSE - news) 13.3 -36.8 20.00 1.47
Apple (AAPL:Nasdaq - news) 31.1 -65.0 18.28 1.03
Source: Marketguide.com
Instead of focusing on these mostly dismal growth numbers, stock pickers are checking out the sale prices of PC stocks; the double-digit gains the group has seen in January follow last year's clobbering, so valuations are still low. "Given the news we all know, and where valuations have gone, it's a great time to initiate and build positions," says Tim Ghriskey, a senior portfolio manager at Dreyfus. "And by the time we realize we're coming out [of a downturn], the stocks will probably be much, much higher."
At Dell, the CEO himself appears to view the stock as a bargain. Michael Dell exercised options to acquire just over 18 million shares in December and January, which outsiders construed as a bullish call on the company's stock.
PBHG's Heppelmann recently bought back into Compaq, which he'd sold in the second half of 2000 on signs of weakening fundamentals. Back then, the stock was around $35; now, though the outlook's still weak, it's trading at around $20. "At this level, the fundamentals are fairly recognized in the stock price," he explains.
But though he's investing in the sector, he remains bearish on its near-term prospects. "Unit growth is still very slow, and the stocks have got a couple of tough quarters in front of them. And there's not really a killer app that will drive the PC side."
Against the backdrop of a faltering economy, most observers aren't too sanguine about the outlook for spending on PCs, on either the corporate or consumer side. In the U.S., businesses buy about half of all PCs, with consumers accounting for another 40% of purchases and governments and schools making up the remaining 10%.
The news that consumer confidence took a big hit in December suggests individual consumers are probably becoming less willing to shell out for replacement computers.
In the near term, companies aren't likely to funnel cash toward new PC buys either, says Jeffrey Bianchi, an assistant portfolio manager at Aeltus Investment Management, which doesn't have any PC holdings. "If you take a look at technology in terms of your budget, and think about where you'd want spending to occur given a decelerating economy, would you want to go to an upgrade of a PC that would probably give you a marginal benefit? Or would you rather put up that Web site or get more storage capacity?" he asks. "I think overwhelmingly companies are saying they'd rather focus on much more important areas of technology than the PC. It's the first area to cut, and I think the last one to come back in terms of the budget."
A more worrying issue for long-term investors is saturation of the PC market in the U.S. and parts of Europe. "Market saturation is not going to go away. What that means is that, as we go forward, overall growth will become more susceptible to economic cycles," says Charles Smulders, principal analyst at Gartner Dataquest, a technology research and consulting firm. "If you're dealing with primarily a replacement market, you could see spending on PCs be delayed until the economic picture improves."
Another cause for concern is the likelihood of continuing pricing pressures. "There is little doubt in our minds that the PC industry will continue its full-blown PC price war throughout the first half of the year, if not longer," writes Eric Rothdeutsch, an analyst for Robertson Stephens, in a recent report. "This ensures compressed margins and little top-line growth for the industry during the first half or longer, in our view."
Still, a few investors think PCs have already gotten knocked around too much. "To me, the desktop is not dead. I think it will be impossible for everybody to do everything from a handheld device," says Dreyfus' Ghriskey. "I think in time these companies will produce some type of handheld instrument and be competitive in that field. You've basically got really good manufacturing, packaging and marketing companies here, whether it's Dell or Compaq or Hewlett (HWP:NYSE - news) or IBM (IBM:NYSE - news). They're not probably going to lead the market into some of these areas, but they'll be right on the heels of the leaders."
His picks are Compaq and Dell, which rank No. 1 and 2, respectively, in market share for PC sales worldwide. But Ghriskey isn't especially interested in that line of business. He's attracted by both companies' success at selling services and storage products to big companies. "Compaq has gone down much further into the enterprise space" relative to its competitors, he says, "and I think Dell is going to play catch-up very fast there."
At PBHG, Heppelmann also taps Compaq. "To me the exciting part of the company is the server business," he explains. "Aside from the general PC business, Compaq's got a solid server business, which I think is going to continue to ramp." He said he might also take another look at Gateway (GTW:NYSE - news) if the stock edged down in price a little.
Both Heppelmann and Ghriskey say they expect more tough times ahead for the group, though. "I don't think we're in for these stocks to rocket to the moon," says Ghriskey. "There's likely to be continued negative news in terms of pricing and demand. So that keeps us fairly conservative towards the group, but I'd say we're closer to increasing exposure than decreasing exposure."
While it might make sense for big mutual funds to start building positions, individual investors may want to steer clear of PC makers for now, suggests Niles at Lehman Brothers. "If there's a price war in the first half of the year, people don't need to be in a rush to buy," he says.
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