Dell – 4 Concerns for Company’s Outlook
Dell (NASDAQ:DELL) competes with personal computer manufacturers like HP (NYSE:HPQ), Apple (NASDAQ:AAPL), Acer (TPE:2353) and Toshiba, and increasingly against IBM (NYSE:IBM) and others for IT services.
We estimate that Dell generates roughly 22% of its stock value through its desktop and notebook/netbook operations. Although our current price estimate for Dell at $19.25 stands well above the current market value, we highlight four reasons to be cautious regarding the company’s outlook.
1) Lower Margin Outlook
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Competition in the notebook and desktop business has intensified as more competitors move into this business. Over the years, Dell has lost share in the PC business to HP and Acer and we foresee a decline going forward given increasing popularity of Apple’s Mac notebooks. As PC sales are pressured and fixed costs in the manufacturing business continue to remain high, Dell could see lower profit margins in the future.
The chart below examines Dell’s stock price sensitivity to changes in profit margin, the amount of revenue that flows through to operating profit, for its notebook and netbook segment.
2) Broader Slowdown in Technology Sector
An overall slowdown in IT spending by businesses could hurt both Dell’s hardware and services businesses. Although not included in our base case forecasts, Cisco’s (NASDAQ:CSCO) weaker than expected earnings have prompted concern regarding a broad slowdown in technology spending.
Contract notebook manufacturers are also running below expectations, a possible sign of weak notebook demand. As we approach the holidays, the personal consumer segment for PCs typically picks up. If this disappoints, we could see a broader pullback in the tech sector.
The chart below examines Dell’s stock price sensitivity to changes in global netbook and notebook demand.
3) Increased Focus on Services Business
Dell’s services business, which we estimate accounts for roughly 23% of its stock value, has been the company’s biggest value driver over the past few years. However, it is not Dell’s traditional business and strategic mistakes here could be costly. Further, if the recent strength in IT budgets among corporations does not hold up (as the company currently expects) services revenue could decline.
The chart below examines Dell’s stock price sensitivity to changes in consulting and other services revenue.
4) Significant Expenditures to Support Business Growth
Dell is also planning to spend significantly to expand its PC business, especially in China, reporting that it will spend $100 billion in the next decade. Whether this investment will ultimately pay off is unclear. In the meantime, such heavy capital expenditure will erode Dell’s free cash flows.