Dell Computer: Amazing Growth|
Dell Computer (Nasdaq:DELL - news) makes boxes, computer boxes. And it makes more of them than most other companies. In the most recent fiscal quarter, it showed an amazing 42% revenue growth from the same quarter a year ago. Everyone who thought the company had to slow down was wrong. Now the question is: how does it keep growing, not just in revenues but in profitability?
Computer makers like Compaq (NYSE:CPQ - news) , Gateway (NYSE:GTW - news) and Dell have seen the Average Selling Price (ASP) for most computers continue to go lower. As the prices go down, so does the profitability. In order to maintain profit growth, it means the box maker has to either sell more computers and/or build higher value added computers. Unless the computer market continues to expand, the only way one manufacturer can sell more computers is to take market share from a rival. Fortunately, the market has kept expanding, though not at the rapid rate of only a year or two ago. No one understands this market better than Dell Computer, and its strategy is to have it both ways: more market share and more profitability.
The fiscal second quarter (July) showed the results of the strategy: revenues up 42% from the previous year; up 41% from the fiscal first quarter; earnings per share were 2 cents ahead of expectations, coming in at $0.19; that's 50% above last year's report and 19% above the previous quarter. The gross margin for DELL in the quarter was 22%, up 50 basis from the first quarter. The Internet sales growth was nothing less than astounding: $30 million of equipment a day vs. $18 million a day in the previous quarter. Those sales represent 40% of its revenue, and the corporate goal is to have them at 50%. With the strong cash flow, the company repurchased 17 million shares.
According to Morgan Stanley Dean Witter the elements that add up to this success are:
>>> the Internet has been effectively used as a sales tool
>>> a focused effort to regain sales momentum in Europe (22% of sales)
>>> new service and additional product sales efforts
>>> enterprise product and service growth (this is where the higher profitability is for the company)
>>> solid government relationships and sales as the government works on Y2K solutions
With these pistons firing, the consensus among analysts is that fiscal year earnings for 2000 will be $.72, and for 2001, $.98. Morgan Stanley has their estimates at $.77 and $1.03 for the same time periods. There is an analysts' meeting in Austin, Texas, on October 7 and look for upbeat reports and higher estimates from more analysts after that.
A new area for Dell is data storage. That means they're taking on EMC (NYSE:EMC - news) , IBM (NYSE:IBM - news) , and several other big names. But the competitive advantage Dell has: it makes and sells the servers that need the storage capability. That gives Dell the first crack at clients setting up servers for the first time as well as companies upgrading. Data storage is a very profitable part of the computing world, and while competition is extremely tough, Dell has already shown its ability to survive and thrive in one of the roughest segments of the computing business.
Furthermore, Dell sees four key areas where there is room for expansion:
>>> consumer and small business
>>> global expansion
>>> enterprise computing systems
Management estimates there might be as much as $10 billion of revenue increase if these areas are properly developed.
So what does all the growth and optimism cost? At the time of this writing, with the stock at $49.50, the P/E is 64 when using the $.77 estimate for fiscal 2000 from Morgan Stanley; it's 69 when you use the consensus estimate of $.72. It gets closer to its growth rate when the 2001 estimate is in the equation: a P/E of 48 with the $1.03 from MS, and 50 when the consensus of $.98 is the denominator. Estimated growth rate is near 40% for both revenues and earnings. That means the stock is selling at about 1.5 times its growth rate for next year, and about 1 time for the year 2001 report. With that type of valuation, there isn't any room for a slowdown in sales. Investors have already bought into Dell's program and are true believers. If there is a slip-up in growth, revenues or earnings, this stock is vulnerable. It suffered that fate earlier in the year when it announced earnings right on the mark but the revenue growth had slowed.
Dell is a great company and is a leader in its group. It's the kind of stock that deserves watching and when there is an adverse quarter or announcement, an investor can buy it at a reasonable valuation. Right now, with a P/E ratio of almost twice the average P/E of the S&P500, with a P/E ratio that is the highest in the company's history both in absolute and relative terms, it's a stock that needs to grow even faster than expected if it's going to keep heading north.
- Ted Allrich
The Online Investor
Sept. 06, 1999