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Dells baby steps arent enough
Yes, the PC maker is ending its monogamous relationship with Intel, and keeping quiet about guidance. But its too soon to forecast a turnaround.
By Robert Walberg
Apparently Dells status with investors has fallen so far over the past year that the mere absence of more bad news is considered a buying opportunity.
How else do you explain the stocks 3.3% gain in after-hours trading Thursday in response to news that net income in the second quarter fell 18% on a 6% increase in revenues.
Just a couple weeks ago, Dell (DELL, news, msgs) warned investors that its earnings and sales would fall shy of earlier guidance due to aggressive price cuts. The company deemed such cuts necessary to recapture market share from hard-charging competitors such as Hewlett-Packard (HPQ, news, msgs). Earlier this week, Hewlett reported much-better-than-expected sales and earnings.
Given the need to lower prices to draw customers, Dell also announced that it will begin to ship servers later this year with microprocessors built by Advanced Micro Devices (AMD, news, msgs). Until now, Dell was the last of the big PC makers to deal exclusively with chip leader Intel (INTC, news, msgs) -- a decision that some thought handicapped the companys pricing flexibility. The announcement sparked a rally in the shares of Advanced Micro, and an understandable retreat in struggling Intel.
The last warning
Its easy to understand why Dells gradual shift away from Intel is good news for Advanced Micro. But its less clear that it will solve Dells woes. Yes, it might help the company defend its margins, but until Dell proves that it can win back customers and grow revenues at a better-than-industry rate, theres no reason to jump back into the stock.
Dell has issued a revenue warning in each of the last three quarters -- one big reason why the stock is down 40.3% over the last 52-weeks. Dells solution: It will no longer issue specific guidance on a quarterly basis. Tough to imagine how less clarity is a good thing. Then again, it will keep the company from overestimating sales and earnings quarter after quarter.
So lets see. Dell appeases critics and consumers by ending its monogamous relationship with Intel. For now, however, the shift is confined to servers, which represent less 10% of total revenues. In other words, the shift wont have an immediate or significant impact on margins and profits.
Speaking of margins, gross margins fell 0.4% to 17.4%. Plans to cut prices in order to restore growth suggest that margins will continue to erode in the future. Sales will need to pick up significantly in order to restore meaningful profit growth, and theres no sign thats going to happen -- at least not domestically.
As noted in my StreetPatrol article earlier this month, one of Dells biggest problems has nothing to do with price. The company is losing customers to poor tech support and customer service. To its credit, management cited improving its customer relationships as job one in righting the ship. The firm will spend as much as $100 million to expand call centers and hire more help. Unfortunately, winning back dissatisfied customers is not easy. It will take time for Dell to prove that it is committed to improving its relationship with clients. The increased staffing will cut into margins and potentially profits. Again, no reason to buy the stock just yet.
Not enough good news
There were a few positives in the report. Dell is witnessing strong growth in Asia as sales in Korea, India and China rose by 54%, 40% and 29%, respectively. Overall, international sales were up 12% -- nearly twice the growth of total sales. International sales now make up about 44% of total revenues.
Dell also generated cash flow of nearly $1 billion in the quarter, bringing total cash and short-term investments up to $11.1 billion. Thats a whole lot of green -- cash Dell can use to buy back shares. Reducing share count is one way to bolster EPS growth, though it would be much better if the gains resulted from strong sales and improved margins. But in Dells case, shareholders will take what they can get. Dell bought back nearly 58 million shares last quarter.
There was simply not enough good news in Dells quarterly report to justify buying the stock. Domestic PC and mobility sales remain sluggish, customer service is still a big problem, overall demand for PCs appears to be slowing and margins will come under pressure from the new strategy.
To top it off, investors will have even less clarity regarding company expectations now that management refuses to give guidance. Ill stick by my view from earlier this month that Dell be ready for a real rebound until hit reaches about $20 a share. If there are any short-term gains from the Intel news, Dell owners would be advised to sell and lock in any gains.
At the time of publication, Robert Walberg did not own or control shares of any companies mentioned in this article.
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