Citigroup Cuts Dell to Sell

It says the PC giant needs to consider letting margins shrink.
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The pricing advantage enjoyed by

Dell

(DELL) - Get Report

is eroding as competitors adapt its inventory and supply-chain innovations, and the company needs to contemplate lower margins to preserve its franchise, Citigroup said in downgrading the stock to sell Friday.

The brokerage slashed its price target on the computer company's shares to $28 from $37, saying Dell must adjust its profitability expectations in order to kick-start growth and market share. In premarket trading Friday, the shares slipped 74 cents, or 2.6%, to $27.50.

"Dell management has been vocal that the business model functions optimally when PC and server units are growing above-market -- this has not been the case for several quarters. Given that Dell's price advantage has eroded to 5% or less since '01, a margin reset is necessary to rewiden the price gap and gain share," Citigroup wrote.

"There is historical precedent for such a reset," Citi wrote. "When end-market growth decelerated through calendar 2000, Dell ultimately slashed gross margin by 300 basis points in a single quarter in order to take share during the downturn and position for the next upturn."

Citi noted that Dell's stock fell from $42 in July to $30 at the end of 2005, and blamed the decline on the company's inability to outgrow the global PC market in unit terms for the first time in a decade.

"With Dell's highly profitable U.S. PC business going ex-growth in the first calendar quarter of 2006, further end-market end market deceleration likely, especially in Dell's largest segments and geographies, we think the probability of a 'margin reset' is rising," Citigroup said.