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The Trouble With Dell's Beat

A day after earnings, investors gauge whether the company has begun to climb out of its hole.

SAN FRANCISCO --

Dell

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says demand for its new line of snazzy notebook PCs is booming.

The only trouble is that the company can't seem to figure out how to make the notebooks properly.

Glitches in the notebook painting process, as well as a shortage of flat panels, prevented Dell from fulfilling customer orders during the second-quarter, an ironic twist on the company's new consumer slogan "yours is here."

In a sense, this is indicative of the entire overhaul under way in Round Rock, Texas. For every sign of success at Dell, there's an equally glaring reason to be wary.

Dell bulls were crowing after Thursday's earnings, celebrating what they insisted were the first fruits of the PC maker's turnaround.

Dell beat Wall Street's revenue and EPS expectations, triggering some positive notes from the sell side. Goldman Sachs raised its price target on the stock fo $33 from $32. Deutsche Bank and Morgan Stanley hiked earnings expectations.

But the stock's muted reaction attested to a more cautious view, as investors gauge whether the company has really begun to climb out of its hole.

Shares of Dell were off 10 cents at $28.36 in midday trading Friday.

Sure, Dell beat Wall Street estimates. But those numbers were always somewhat arbitrary, given that Dell hasn't provided financial guidance, or even held a conference call with analysts, in nearly a year.

And the fact is, Dell's closest competitor,

Hewlett-Packard

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, grew its top line more than three times faster than Dell during the quarter, a feat that's even more significant when one takes into account H-P's much larger revenue base.

"It almost seems to the point where Dell has been beaten down so badly, and people have such low expectations, that they come out with this number and everybody's applauding," says Daniel Morgan, a portfolio manager at Synovus Trust Company.

Morgan, whose firm owns no Dell shares, says it's still too early for him to get excited about the stock.

Of course, Dell doesn't need to blow the roof off at this point in its rehabilitation; only to demonstrate that it is improving. And the company's gross margin, which increased to 19.9% from 15.5% at this time last year, was impressive.

For Dell bulls, this rising gross margin reveals a new leverage that will allow Dell to deliver outsize earnings relative to revenue growth.

The causes of the gross margin uptick were low component costs and higher average selling prices. And while favorable component costs may soon go away, Goldman Sachs analyst Laura Conigliaro sees a rainbow of additional margin magic on the horizon.

"We are in an early enough stage for forecasts to keep rising as Dell goes through various phases of its turnaround, including more layoffs, more cost efficiencies, greater us of ODMs, better procurement, more cost-efficient designs, coupled with revenue enhancers such as more appealing product line, better pricing discipline, and closely allied, more upsell," Conigliaro wrote in a recent note to investors.

Goldman Sachs makes a market in Dell shares and has received compensation from Dell for investment banking and non-investment banking services in the past 12 months.

Dell said in June that it planned to slash 10% of its workforce. Curiously though, the company's total headcount has actually increased by about 2,300 employees (including temporary workers) since then.

In some ways, the jumble of positive and negative nuggets in Dell's report underscores the uncertainty about the exact nature of its comeback plan. Is Dell a cost-cutting story, or is it striving to recapture its erstwhile sales growth and market share?

The ambiguity has been exacerbated by the company's lack of briefings with the Street, although Dell promised Thursday to finally host a conference call about its plans in November.

"Dell is still going through a multi-quarter if not multiyear transition to get back to a better growth rate," says AtlanticTrust SteinRoe's Chuck Jones, which has a position in Dell, though not as one of its core holdings.

"I don't think they're even close to declaring victory, and I wouldn't be either," says Jones.