Dell Earnings Could Take a Hit on Taiwan-Related Supply Snags

Dell may use Thursday's analyst meeting to guide third-quarter earnings expectations lower as a result of the September quake in Taiwan.
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The uncertainty factor is high in Round Rock, Texas as

Dell

(DELL) - Get Report

readies for its fall analyst meeting Thursday morning. Dell's super-efficient supply chain could end up being its Achilles heel, leaving it with possibly the highest exposure of any computer company to the Taiwan earthquake.

The result may be that Dell will guide the Street to lower its earnings estimates for the company's third quarter, say analysts who follow the company.

Last week, Dell CFO Tom Meredith told anxious money managers during a break at the

Banc of America

investment conference that it was too early to gauge the impact of the Taiwanese earthquake on its third quarter, which ends at the end of this month, according to a money manager who was present.

Since Dell carries little inventory, its reliance on Taiwanese suppliers may impact its ability to churn out PCs, laptops and workstations. Although its stock price has remained relatively stable since the Sept. 21 quake, both money managers and analysts are beginning to think it's likely that Dell will fail to meet earnings expectations for the quarter.

"Dell has a heavy Taiwan exposure and that should cause around two quarters of disruption at the company," says Don Young, a computer analyst at

PaineWebber

who has had a neutral rating on Dell since May. PaineWebber has no underwriting relationship with Dell.

The analyst consensus estimate on

First Call/Thomson Financial

calls for Dell to earn 20 cents a share for the quarter.

Hewlett-Packard

(HWP)

CEO Carly Fiorina warned the Street on Friday that Taiwan -- along with poor Unix sales in North America -- would push year-over-year revenue growth to the low end of initial projections (10% to 13%) for its fourth quarter ending Oct. 31. Fears of Taiwan's impact drove H-P stock down as much as 20% over the last two weeks.

H-P's problems could extend to Dell, says

BancBoston Robertson Stephens

analyst Dan Niles, who lowered his Dell rating from a buy to long-term attractive Friday.

Salomon Smith Barney's

Rich Gardner, who rates Dell shares a buy, warns that Dell's earnings could fall to around 16 to 18 cents per share if Dell's production is hurt by supply problems. Neither firm has participated in any recent Dell underwriting.

"The direct model works both ways," says Kai-Teh Tao, a money manager with

Watson Investment Partners

who is not a Dell investor. With its low inventories and fast turnarounds, the money manager says Dell benefits the most when prices fall, as they did for much of 1999. But when the environment changes and rising component prices come into the equation, "the direct model works against you."

Spot prices for DRAMs, the most common form of PC memory, have shot up to 16 1/4 in October from 4 in July and contract pricing has risen to around 10 from 5, points out Gus Richard, an analyst for San Francisco-based

Emerging Growth Management

, a money management firm which invests in small-cap companies. Richard, a former semiconductor analyst for

Hambrecht & Quist

, says Taiwan chip manufacturing plants will lose two weeks of supply due to the quake at minimum and another "three to six weeks of production wafers when all is said and done due to electricity outages and ramp-up problems in yield."

Apart from memory-chip shortages, PC companies are finding that graphic chip inventories are also low. Approximately 80% of graphic chip sets are produced in Taiwan for laptops and personal computers, according to Danny Lam of

Fisher-Holstein

, a tech research firm. "Week one after the quake was a total write-off, week two was at only 50% capability and week three is approaching prequake levels of production," reports Lam.

Toronto-based graphics chip maker

ATI Technologies

(ATYT)

, the world's leading supplier of video and 2D/3D graphics accelerators to PC outfits, just told third-tier computer customers there would be a 4- to 6-week delay in supply due to the quake, notes Lam. But an ATI spokesman says the earthquake problems have had little impact so far. "It's a net neutral situation for us and so far there is no indication that we are in a delay situation as of yet," says ATI Technologies spokesman Brian Chadderton.

Nvidia

(NVDA) - Get Report

, which recently has had some key design wins for its graphics cards with

Gateway

(GTW)

and Dell, said Sunday its production has been affected by the Taiwan quake, although it won't impact earnings until its fourth quarter.

Nevertheless, even first-tier PC makers such as Dell will be forced to pay more for components across the box, says Tao.

Niles agrees. "Margins are under tremendous pressure given the price premiums being paid," the BancBoston analyst writes in his Oct. 1 report.

PaineWebber's Young says Dell can't ship its new Dell Inspiron, the 3700, for 30 days due to the quake and is instead promoting its 3500 line -- an older model -- after knocking $200 off the list price. This kind of price manipulation, he suggests, could crimp margins. A Dell spokesman responds that Dell isn't experiencing any delays on the Inspiron line yet due to Taiwan nor on any of its other PC-related products.

Last week, Dell CFO Meredith told

TheStreet.com

he was comfortable with analyst estimates. If the component shortage headaches persist, Dell could end up with one heck of a migraine come earnings announcement time.