Can Dell Sustain Improved Profit Margins?
Dell (NASDAQ:DELL) reported strong results for Q4 2011 during its February 15th earnings release, with $15.7 billion in revenues (up 5% over the same period last year) and significant margin improvement. Dell is known for its product line of desktop and notebook PCs as well as its printers and PC displays. Dell primarily competes with HP (NYSE:HPQ) and Acer (TPE:2353) at the top end of the PC market, [1] as well as IBM (NYSE:IBM) and others in the IT services business.
Revenue for Dell’s fiscal year 2011 grew 16% from the previous year, reaching $61.6 billion. Dell saw revenue improvement across all business segments. While revenue growth was particularly strong in segments like services and servers & networking, which increased at 36% and 26% annually, other segments like desktops, notebooks & netbooks and storage also saw respectable sales improvement.
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One particular highlight for the fiscal year was a 1% improvement in overall gross margin. Other expenses like SG&A and R&D also decreased as a percentage of sales, resulting in a 1.5% increase in the firm’s operating margin.
Based on Dell’s recent margin strength and improved outlook, we have updated our forecast for the company. We currently estimate that notebooks & netbooks comprise the largest source of value for Dell, representing 19% of our $22.39 price estimate for Dell stock. Our price estimate stands well ahead of market price.
See our full analysis and $22.39 price estimate for Dell
Dell Cuts Down on Expenses
During Dell’s fiscal year 2011, the company’s gross margin increased by 1% due in part to strong supply chain execution and continued broad component cost declines. With reductions in other expenses like SG&A and R&D as well, Dell’s EBITDA margin for its notebook & netbook business saw an incremental 1.5% over 2009 levels. Similar EBITDA margin improvement was also observed by Dell’s other business divisions.
While we currently forecast that EBITDA margins for Dell’s notebooks & netbooks division will remain flat in the years ahead, potential difficulties in sustaining cost cuts could pressure profit margins and present downside to our price estimate for Dell stock.
Below are a few key concerns that we believe could potentially hinder Dell’s notebook & netbook EBITDA margins in the years ahead.
1. Rising Popularity of Tablet Devices
Tables are rapidly increasing in popularity amongst consumers. It now seems realistic that tablets will soon give desktops, notebooks and netbooks a run for their money in the near future.
A flurry of new tablet launches could incite a pricing war across manufacturers. This would not be a welcome development given the tremendous R&D spending associated with the device’s development. Overall, these factors could strain profit margins for manufacturers that are forced to significantly cut prices to remain competitive, thus dragging down profit margins on notebook & netbook sales.
2. Increase in Component Costs
As the economy continues its recovery and consumer demand increases, component costs for notebooks & netbooks will follow a similar path. This could further strain EBITDA margins on notebooks & netbooks, and pose a separate headwind to our bullish outlook for Dell.
Drag the trend line in the interactive chart above to see the affect of various notebooks & netbooks EBITDA margin scenarios on Dell’s stock value.
Notes:- Global PC Market, IDC [↩]