The PC industry was good to investors in 2004, despite a slow start. Dell (DELL) and even troubled Gatewayundefined sported advances on Wall Street of 25% and 41%, respectively, while a reinvigorated Apple Computer (AAPL) appreciated by an astonishing 212% by mid-December.
All three of the sector's publicly traded pure plays were helped by a second-half rally that floated a lot of technology boats, and by strong sales of PCs as well. Market researcher IDC estimates that worldwide sales of desktop PCs, notebooks and low-end servers will have increased by 14.5% by the time the ball dropped in Times Square.
Apple's 2004 Shine
Apple, of course, is becoming less of a computer company every minute -- and is therefore less vulnerable to the ups and downs of the PC market. In its fourth quarter, for example, sales of Apple's hit iPod music player and related services such as iTunes accounted for 27% of the company's total revenue. In the December quarter, when consumer-electronics items top holiday shopping lists, the iPod will contribute 32% of the company's revenue and about 26% of gross profit, estimates Goldman Sachs analyst David Bailey.
The coming year is not likely to be a replay of 2004, but that's not to say it won't be interesting.
The growth in PC sales is expected to slow to 10.1% in 2005, said IDC analyst Roger Kay.
But with IBM out of the PC business, many analysts believe Dell and Hewlett-Packard are likely to pick up market share while customers wait to see what Lenovo Group, the new owner of Big Blue's long-suffering segment, has in mind.
Apple will likely roll over rivals that are hoping to grab a share of the online music business, but forecasting significant appreciation for its already expensive stock is a challenge.
Charlie Wolf, of Needham, one of three sell-side analysts who downgraded Apple in early December, said in a note to clients: "The stock has had a spectacular run in 2004, chiefly on the strength of exploding iPod sales. In our opinion, the upside the iPod might deliver going forward is now captured in the company's share price."
Even Ryan Jacob, the generally bullish manager of the Jacob Internet Fund, has pared his position in the stock way down, and said that looking for upside "is a very tough call. The wild card is how well will iPod sales translate into computer sales."
Making a Move to Mac
Ryan and other analysts say that some iPod buyers are so happy with their purchase that they've switched from Windows-based computers to Macs. Within the industry, that trend is called "the halo effect."
Citing the cost and difficulty of switching platforms, Wolf figures that few Windows users will jump to Macs, but "Apple's leadership in software applications that manage digital content could translate into a much higher switching rate than we're forecasting and, in turn, a much higher valuation." Wolf downgraded Apple from buy to hold. (His company has an investment banking relationship with Apple.)
Not all of Apple's success in 2004 was based on the iPod. The Cupertino, Calif., company is now handling with panache the fundamentals of its business. "Apple has dramatically improved several of its balance sheet items, specifically its cash conversion cycle and inventory, to levels that rival industry leader Dell," Goldman's David Bailey said in a note.
"At the same time, strong revenue growth should unlock Apple's operating leverage in fiscal 2005 and 2006, even as the company increases spending on R&D and its retail outlets," he said.
Even so, Bailey doesn't think this is the right time to move money into the company. "Apple's premium valuation is well deserved in our view, but does not leave enough room to justify new money entering the name at this point," he wrote. Noting that Apple shares tend to be news-driven, Bailey advised his clients to wait for December earnings (due Jan. 12) and the Macworld Conference and Expo (Jan. 10-14). "After that point, the stock is likely to pause, and investors should be able to reassess Apple shares with a clearer view of the company's 2005 potential." (Goldman has a recent investment-banking relationship with Apple.)
In a sign that traders share some of those concerns, short interest in Apple jumped 57.2% in November (the most recent reporting period), but a squeeze isn't likely because the "days to cover" metric is quite low -- at 1.51%.
Strength in Dell's Numbers
Unlike Apple, Dell did not have a standout product in 2004, but it dominated sales of PCs and, as usual, executed extraordinarily well. And like Apple, it's not clear if there is a short-term upside to the stock, though few analysts would argue against
Dell's fundamental strength.
"Long-term buy, yes; short-term buy, no," commented Allan Lowenstein, co-portfolio manager of the John Hancock Technology Fund, which holds shares of Dell. Historically a price in the mid-to-upper $30s is a better entry point, he added.
Dell's performance was very strong in 2004. "Dell continued to lead the market and expand its share with more than 20% growth
in units shipped year over year. Growth in portables and in international markets were each more than 30%," said IDC's Kay.
Apple, by contrast, held a market share of just 1.9%, ranking 10th worldwide.
Dell's success wasn't limited to PCs. Morgan Stanley analyst Rebecca Runkle said that the Round Rock, Texas, company's strong showing in printers, consumer-electronics products and services could help it achieve high-teens revenue growth "even in a high-single-digit PC-unit growth environment." But those items won't contribute much to the bottom line in the short run, she added.
Runkle reaffirmed her "overweight" rating on Dec. 14 and raised her target price for Dell shares by $3, to $45 a share. (Morgan Stanley has a recent investment-banking relationship with Dell.)
On the same day, A.G. Edwards analyst David Wong raised his target price by $5, to $50 a share, based on his fiscal 2007 EPS estimate of $1.86 on sales of $64.7 billion. (Dell is currently in the fourth quarter of fiscal 2005.) A nine-analyst consensus polled by Thomson First Call is expecting a profit of $1.83 on sales of $65.1 billion. (A.G. Edwards does not have an investment-banking relationship with Dell.)
Gateway ranked third in unit sales of PCs in the U.S., but it was not among the top five worldwide vendors -- Dell, H-P, IBM,
. "Gateway grew shipments year-on-year for the first time since the third quarter of 2000 against a relatively easy compare. However, it failed to boost shipments sequentially during what should have been its strongest period -- the consumer-heavy fourth quarter," Kay said.
The company recently raised its
fourth-quarter earnings guidance to 3 cents or 4 cents a share from its earlier projection of 1 cent to 2 cents a share to reflect the retirement of preferred stock to be funded by a series of new convertible notes. Wall Street was expecting 2 cents. Including one-time gains and charges, the company expects to earn 22 cents to 24 cents a share.
Piper Jaffray analyst Les Santiago said "we would be aggressive buyers on any weakness caused by the convertible offering or from caution about first-quarter 2005 seasonal weakness." He said the company trades at 0.4 times to 0.5 times price to sales on a forward 12-month basis, well below its peer group. Though a discount to more successful companies is to be expected, Santiago said that the current valuation of Gateway appears not to take into account the changes in the company since
the merger with
in early 2003.
Similarly, Robert Chira of Fulcrum Global Partners conceded that guiding in line with 2005 consensus was a letdown for some investors. But he said the forecast showed enormous progress compared with the 8-cent profit expected by Wall Street two quarters ago and analyst expectations of a loss of 22 cents a share three quarters back. (Neither Fulcrum nor Piper Jaffray has an investment banking relationship with Gateway.)