Article From Barron's Online 5-21-98
Weekday Trader
Can Dell Really Do No Wrong?
Lisa R. Goldbaum
In recent years, Dell Computer (DELL) has been the kind of stock investors
pray for.
Surpassing stock market stalwarts like Intel (INTC), Microsoft (MSFT),
Cisco Systems (CSCO) and Coca-Cola (KO), 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 (CPQ), 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 (HWP)--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. |
