Wednesday, December 12, 2012

Dell Sinks With Market, Downgrade

Dell’s profit report Tuesday was a mixed bag: earnings per share that beat analyst estimates but revenue that missed expectations. Pessimism seems to be ruling over optimism for the coming months, with some flickers of hope.

Shares of Dell (DELL) are down nearly 3%, or 37 cents, to $15.26.

FBN Securities Analyst Shebly Seyrafi notably downgraded the stock to Sector Perform from Outperform Wednesday and lowered FBN’s price target from $20 to $17, saying constraints on hard disc drive (HDD) shipments could be a large negative factor for the first quarter of 2012.� With flooding in Thailand, HDD problems were already on peoples’ minds; the sink in revenue could be an indication of things to come.

But Seyrafi lists six reasons for the downgrade:

  • 1) A tougher pricing environment, forcing Dell to choose between losing share or accepting lower margins.
  • 2)� Guidance for 2012 operating income growth implies that operating margin will decline.
  • 3) HDD prices have spiked (from around $55 before the Thailand floods to as high as $135 recently), hurting gross margins.
  • 4) Weak growth: in the Americas (-5%), Europe-Middle East-Africa (+4%), while it is only growing well in Asia-Pacific-Japan (+10%).
  • 5) Public segment (29% of revenue) did not grow well, -2% Y/Y and -2% Q/Q, a normally strong quarter.
  • 6) Dell-owned IP storage (Compellent/EqualLogic) revenue of $388M declined Q/Q for the first time (from $393M in FQ1), although it was up 23% Y/Y.

Sterne Agee Analyst Shaw Wu raised his earnings-per-share estimate Wednesday, calling the quarter “decent.” He highlighted the EPS beat, gross margin “surprisingly higher at 23.1% versus the consensus of about 22.5%” and said Dell “executed much better than expected on HDD shortages.” He has a Neutral rating on the stock and a price target of $17 based on a 7.5x multiple on our calendar 2012 earnings of $2.30 per share.

“We are trimming our revenue but raising our EPS outlook due to a higher margin profile. For FY12, we are now at $62.1 billion in revenue and $2.20 in EPS (from $62.6 billion and $2.07 in EPS) and for FY13, $64.3 billion and $2.30 in EPS (from $64.8 billion and $2.00 in EPS). We are leaving our price target at $17 reflecting a 7.5x multiple on our CY12 EPS of $2.30 (from $2.00) … We rate DELL shares NEUTRAL as we remain concerned with the company’s longer-term fundamental position and may face more difficulty making further operational improvements. In our view, the company faces formidable competitors in both its core PC and enterprise businesses.”

Citi Analyst Richard Gardner reiterated his Buy recommendation and has a $20 price target. He too cited the earnings beat due to gross margins that were better than Wall Street expected. And he acknowledges softer demand in mature consumer markets, U.S. and European government business and aggressive price competition. But Gardner notes that

“management suggested that drives should not be a meaningful issue in 4FQ given strategic purchases in October and volume commitments from HDD vendors … management was not concerned about increased HDD costs pressuring gross margin as: 1) the deflation in the remaining components will more than offset the increase in drive costs, and 2) Dell is already passing the extra cost to customers through higher PC pricing.”

Gardner’s conclusion:

“We remain constructive on Dell shares as they trade below 6x our fiscal 2012 earnings per share estimates (ex-tax adjusted cash), based on fairly conservative assumptions (1-2% revenue growth with no margin expansion during next 2 years). We note that free cash flow yield is at 16-17%.”

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