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Dell's Report Gives It Some Lift

Updated from Aug. 14

Dell shares gained 83 cents or 2.6% to $32.22, a day after delivering another quarter of double-digit sales and profit growth.

On Thursday Dell (DELL) said it had hoisted sales in its latest quarter by a robust 16% from last year's levels, lifting net income an even sturdier 24%. As a bonus, it guided for sales above Wall Street's expectations in the quarter now underway.

The computer hardware maker now has met or beaten Wall Street estimates for 10 successive quarters in a row.

Dell's strong showing prompted A.G. Edwards to upgrade its rating to a buy from a hold, citing Dell's solid bottom-line growth in the midst of broader IT sluggishness. Analyst Shebly Seyrafi tagged the shares with a price target of $38 based on discounted cash flow analysis.

Among other inputs, his analysis assumes Dell can push up its operating margin to 9.3% from the current 8.6% (which is in itself an increase from an operating margin of 8% in last year's second quarter). Seyrafi also assumes that over the next 10 years, Dell's revenue growth will gradually slide from 15% to 5%.

A.G. Edwards hasn't done banking for Dell.

Meanwhile, U.S. Bancorp Piper Jaffray nudged up estimates for Dell in the current fiscal year 2004, increasing his revenue outlook to $41.1 billion from $39.8 billion and EPS to $1.01 from $0.98.

But the bank sounded a note of caution for investors thinking of buying into Dell. "While the stock remains a core technology holding, we would be more aggressive on pullbacks," wrote analyst Ashok Kumar. "PCs could record subpar aggregate demand for the forseeable future."

One or more affiliates of U.S. Bancorp has recently provided commercial banking services to Dell.

To be sure, investors initially reacted to Dell's report with a distinct lack of enthusiasm, pushing the shares down slightly in after-hours trading following the release of its second quarter results on Thursday. "The reality is the bear call on the stock has been [slowing declines in] component prices and you saw a 10 basis points blip in gross margins. That is why the stock traded off," says Pacific Crest analyst Brent Bracelin.

But he says it was a "function of more aggressive pricing, not component costs, that drove a little pressure on margins." Bracelin estimates that Dell's average component cost per unit still declined by $6 from the prior quarter, with those declines accounting for the majority of the $10-per-box sequential decline in price (the remaining $4 slide in price presumably came as Dell got more aggressive on prices).

"They're still driving 20-plus percent growth in earnings despite revenue growth that is slowing down a little because of aggressive pricing pressure. They continue to gain share. So it's business as usual for Dell, another good quarter," he says. Bracelin has a buy rating on Dell; his firm hasn't done banking for it.

The computer hardware maker reported in-line revenue of $9.8 billion for the second quarter of fiscal year 2004, helped along by strong growth in servers and storage systems. Net income of $621 million amounted to 24 cents per share. Both earnings and revenue met guidance and Wall Street estimates.

The company said its total product shipments in the July quarter 2004 were up 27 percent from one year ago, growing at more than four times the pace of the rest of the industry.

Alluding to fierce price pressure from competitors, president Kevin Rollins noted that the company had delivered profitable growth "regardless of the pace of industry demand and the appetite of others to generate sales, even at a loss."

Later on the call, he confirmed to an analyst that Dell had seen "a slight uptick in aggression from both H-P (HPQ - Get Report) and IBM (IBM)" in the most recent quarter.

Meanwhile, Dell said October quarter sales are likely to total around $10.5 billion, above consensus estimates for $10.3 billion. The sales forecast implies growth of 15% over the prior year, while in-line guidance for EPS of 26 cents suggests growth of 24%.

Lately the cost of computer components such as flat panel displays and memory has been declining at a slower rate than in the past, but Dell said it nonetheless expects costs to drop in the quarter underway.

On the call, management said it's seeing signs of recovery, pointing out that the hardware industry has now seen four consecutive quarters of modest year-on-year unit growth. "We are seeing stabilization in the IT market in terms of the tone from our customers. They're feeling better about the macro environment," said one Dell officer. "But managers of companies are risk averse. We think there need to be a couple more quarters of economic improvement before we see IT budgets growing substantially."

Added Rollins in a separate comment, "We don't see any fundamental huge uptick in demand particularly in large corporate markets. We have seen a little [strength] in Europe, in Asia, and business has been pretty good in SMB [small and medium-sized businesses]." Dell has managed to outperform the industry despite slow growth among the biggest companies since they account for a portion of revenue only in the high teens, he added.

In the July quarter, Dell managed to cinch costs to a record-low 9.6% of revenue, down from 9.9% a year ago.

It reported that operating profit as a percentage of revenue increased to 8.6%, which it said was the highest in nearly three years. That compares to operating profit equal to 8% of revenue a year ago.

Also on the call, Dell suggested that its nascent Dell-branded printer business is in the black. Responding to an analyst question, management said, "Rest assured that we don't do things that detract from the overall profitability of the company. We won't be talking about how much profit we're making."

Dell acknowledged its gradual entry into the consumer electronics business, while saying it plans to move into the area "step by step." "We will not lurch onto the stage with 150 different products," said one officer, referring to H-P's high-profile consumer products launch earlier this week. Dell added that it's targeted a number of "interesting products" related to music and flat-panel TVs.

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