Dell's Comeback Looks Good, for Now
SAN FRANCISCO --
Dell
(DELL) - Get Report
showed the Street it has plenty of fight left in it, with a whopping $400 million revenue beat.
But beneath the triumphant top line, the old champ still seems to be undergoing an identity crisis that's evident in its income statement.
While Wall Street is cheering Dell's comeback -- sending its shares up 7.8% to $23.52 in midday trading Friday -- a real transformation of the PC maker won't be possible until it comes to terms with this fundamental character trait.
In its
fiscal first quarter, Dell boosted revenue 9% year over year to $16.1 billion. Sales were above Wall Street expectations, with the company showing nice improvements in all the important places: notebook and server sales were strong, and sales outside the U.S. made up the majority of revenue for the first time in company history.
Yet the solid sales numbers didn't fall all the way through to the bottom line: Net income of $784 million, was up only 4% from a year ago; and this despite aggressive cost-cutting within the company.
The cause of the disparity is a tug of war between Dell's operating margins and its gross margins.
On the operating expenses side, Dell is making significant progress. The company slashed its headcount more aggressively than expected in the first quarter, driving costs down and pushing up its operating margin.
But the improvement in operating expenses is being offset by a weakening gross profit margin, which fell to 18.4% in the first quarter from 18.7% in the fourth quarter. In the year-ago period, Dell's gross margin was 19.3%.
The most obvious explanation: prices.
As Dell moves into retail stores, selling PCs at
WalMart
(WMT) - Get Report
and
BestBuy
(BBY) - Get Report
, its average selling prices can be expected to see some downside, particularly as competition with other PC makers like
Hewlett-Packard
(HPQ) - Get Report
,
Lenovo
and
Acer
heats up.
Indeed, as impressive as Dell's unit shipments were during the quarter, revenue lagged considerably, points out Daniel Morgan, a portfolio manager at Synovus Trust.
While Dell's notebook shipments were up a stunning 43%, notebook revenue increase only 22%. By contrast, H-P's notebook revenue increased 31.5% in the quarter.
Dell boosted its shipments of servers to corporations by 21%, but revenue grew only 4%. That's better than H-P, whose revenue for comparable servers was flat, but it speaks to the pressure on prices.
"You have to strip out some of this headline stuff, and start looking at what are you making on this in terms of dollars," says Morgan, whose firm owns shares in H-P, but not in Dell.
"You are seeing a pulse coming across in terms of things improving
at Dell. But they still have a lot of work to do," says Morgan.
In the post-earnings conference call Thursday, Dell CFO Don Carty acknowledged that the company had been overly aggressive in cutting prices for certain products during the quarter.
"Sometimes when you see some softness you want to test elasticity," said Carty, referring to the notion that slashing prices will spur demand.
But he noted that there isn't much price elasticity in the current environment and acknowledged that Dell probably would have had better profitability if it hadn't cut prices as much.
What this really illustrates is Dell's ongoing quest to figure out what the company stands for. Is Dell the value PC company, the maker of fancy, jazzed-up machines such as its XPS line of products -- or the provider of staid, corporate boxes?
As Dell pushes deeper into new distribution outlets like retail, and expands its footprint in emerging markets, the company doesn't yet appear to have a solid grasp about its position in the market vis-à-vis its many competitors.
Until Dell figures this out, the uncertainty will manifest itself in its gross margin. And investors won't reap the full reward of an otherwise promising turnaround.