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 profitgrowth.

On Thursday Dell ( DELL) said ithad hoisted sales in its latest quarter by a robust16% from last year's levels, lifting net income aneven sturdier 24%. As a bonus, it guided for salesabove Wall Street's expectations in the quarter nowunderway.

The computer hardware maker now has met or beatenWall Street estimates for 10 successive quarters in arow.

Dell's strong showing prompted A.G. Edwards toupgrade its rating to a buy from a hold, citing Dell'ssolid 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 canpush up its operating margin to 9.3% from the current8.6% (which is in itself an increase from an operatingmargin of 8% in last year's second quarter). Seyrafialso assumes that over the next 10 years, Dell'srevenue growth will gradually slide from 15% to 5%.

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

Meanwhile, U.S. Bancorp Piper Jaffray nudged upestimates 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 forinvestors thinking of buying into Dell. "While thestock remains a core technology holding, we would bemore aggressive on pullbacks," wrote analyst AshokKumar. "PCs could record subpar aggregate demand forthe forseeable future."

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

To be sure, investors initially reacted to Dell'sreport with a distinct lack of enthusiasm, pushing theshares down slightly in after-hours trading followingthe 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 aggressivepricing, not component costs, that drove a littlepressure on margins." Bracelin estimates that Dell's average componentcost per unit still declined by $6 from the priorquarter, with those declines accounting for themajority of the $10-per-box sequential decline inprice (the remaining $4 slide in price presumably cameas Dell got more aggressive on prices).

"They're still driving 20-plus percent growth inearnings despite revenue growth that is slowing down alittle because of aggressive pricing pressure. Theycontinue to gain share. So it's business as usual forDell, another good quarter," he says. Bracelin has abuy rating on Dell; his firm hasn't done banking forit.

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

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

Alluding to fierce price pressure fromcompetitors, president Kevin Rollins noted that thecompany had delivered profitable growth "regardless ofthe pace of industry demand and the appetite of othersto generate sales, even at a loss."

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

Meanwhile, Dell said October quarter sales arelikely to total around $10.5 billion, above consensusestimates for $10.3 billion. The sales forecastimplies growth of 15% over the prior year, whilein-line guidance for EPS of 26 cents suggests growthof 24%.

Lately the cost of computer components such as flatpanel displays and memory has been declining at aslower rate than in the past, but Dell said itnonetheless expects costs to drop in the quarterunderway.

On the call, management said it's seeing signs ofrecovery, pointing out that the hardware industry hasnow seen four consecutive quarters of modestyear-on-year unit growth. "We are seeing stabilizationin the IT market in terms of the tone from ourcustomers. They're feeling better about the macroenvironment," said one Dell officer. "But managers ofcompanies are risk averse. We think there need to be acouple more quarters of economic improvement before wesee IT budgets growing substantially."

Added Rollins in a separate comment, "We don't seeany fundamental huge uptick in demand particularly inlarge corporate markets. We have seen a little strength in Europe, in Asia, and business has beenpretty good in SMB small and medium-sizedbusinesses." Dell has managed to outperform theindustry despite slow growth among the biggestcompanies since they account for a portion of revenueonly in the high teens, he added.

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

It reported that operating profit as a percentageof revenue increased to 8.6%, which it said wasthe highest in nearly three years. That compares tooperating profit equal to 8% of revenue a yearago.

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

Dell acknowledged its gradual entry into theconsumer electronics business, while saying it plansto move into the area "step by step." "We will notlurch onto the stage with 150 different products,"said one officer, referring to H-P's high-profileconsumer products launch earlier this week. Dell addedthat it's targeted a number of "interesting products"related to music and flat-panel TVs.

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