Dell: How to Play It

Dell is becoming more competitive and increasing sales, but analysts favor its rivals.
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BOSTON (TheStreet) -- Dell (DELL) - Get Report agreed to purchase 3PAR (PAR) - Get Report on Aug. 16, but lost a bidding war for the data-storage company to Hewlett-Packard (HPQ) - Get Report.

Still, Dell's stock is up 13% since the announcement. Dell is known for making PCs, laptops and printers, but has expanded its range in recent years via a partnership with

EMC

(EMC)

and the acquisition of

Perot Systems

, a services provider, in 2009.

Commercial sales boosted quarterly results. Fiscal second-quarter profit increased 15% to $545 million, or 28 cents a share, as revenue grew 22%. The gross margin narrowed from 20% to 18% and the operating margin contracted from 5.9% to 5.1%, hurt by 22% and 45% increases in the cost of products and services revenue, respectively. Server and networking revenue jumped 35% and services revenue surged 57%. Consumer revenue stagnated at $2.9 billion as the division swung to a $29 million operating loss, proving that retrenchment is an ongoing trend.

Dell boasts an ideal financial position. Although it lost its shot at 3PAR, it has liquidity for more acquisitions to fuel growth. Dell held $13 billion of cash at the end of the quarter and $5.3 billion of debt, converting to a quick ratio of 1.1 and a debt-to-equity ratio of 0.9. Also, its stock is cheap, trading at a forward earnings multiple of 9.4, a sales multiple of 0.5 and a cash flow multiple of 7.3 -- 47%, 86% and 49% discounts to computer and peripheral peer averages. As a result, 20, or 51%, of analysts covering Dell rate its stock "buy," 16 rate it "hold" and one ranks it "sell."

A median price target of $15.42 suggests that the stock will rise 13% in the next 12 months.

Deutsche Bank

(DB) - Get Report

is bullish, forecasting a gain of 46% to $20.

Sanford Bernstein

predicts a rise of 31% to $18. On the other end of the spectrum,

Barclays

(BCS) - Get Report

rates Dell "equal weight" with a $14 target. The bank's latest BarCap CIO survey suggests growth in spending on PCs and storage through the end of the year and into 2011. But, server investment dropped as a CIO priority, which will partially counteract any benefit from PC or storage sales. Cloud computing remains the investable tech theme and Dell offers exposure to cloud, but isn't a pure-play like

NetApp

(NTAP) - Get Report

or

EMC

(EMC)

.

Barclays is "positive" on the industry, but isn't particularly hot on Dell. Its "buy"-rated stocks in the space include EMC and HP, which other tech analysts also favor. HP receives 27 "buy" recommendations, nine "hold" ratings and just one "sell" call. A median target of $53.04 suggests a 29% return. But, Barclays is less bullish, predicting a rise of 21% to $50. The British bank is most-bullish on EMC, its other "buy"-rated large-cap hardware stock. Barclays values EMC at $28, higher than any other researcher, implying a 12-month gain of 39%.

Though Dell remains a solid large-cap tech pick, Hewlett-Packard and EMC outshine it in several categories. For example, in the past three years, Dell has suffered an annualized profit decrease of 18% while EMC has grown net income 4.1%, on average, and HP has boosted its bottom-line 8.3%, on average. Dell is also the laggard in three-year sales growth. Dell's quarterly gross and operating margins and return on assets rank lowest of the three.

EMC's storage and cloud focus render its growth prospects attractive, but from a valuation perspective, HP is a better large-cap tech play. Since CEO Mark Hurd left, HP's stock has tumbled 12%, putting it at a noticeable discount. It trades at a forward earnings multiple of 8.1, a book value multiple of 2.2, a sales multiple of 0.8 and a cash flow multiple of 7.8 -- 54%, 53%, 77% and 46% discounts to peer averages. Unlike Dell, HP pays a consistent, albeit modest, quarterly dividend of eight cents, equal to an annual yield of 0.8% and a payout ratio of 9%.

-- Written by Jake Lynch in Boston.

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