Markets & Finance

Where Dell Says It's Going


By Megan Graham-Hackett Dell Computer's (DELL) Apr. 4 analysts' meeting held few surprises for the investing community, although ahead of the gathering the company did update its guidance for the first quarter of its fiscal 2003, which will end on May 3, 2002. Dell said revenues would come in ahead of its earlier expectations, but earnings will remain in line with the company's prior guidance. Instead of revenues of $7.7 billion, down roughly 4% from the prior quarter, Dell said it expects revenues to reach $7.9 billion, a 2% drop.

The PC maker attributed the upside surprise to strength in the U.S. market for all of its products. Dell also said it expects to beat its prior revenues forecast for the first quarter and to meet analysts' consensus earnings per share outlook of $0.16. In addition to the earnings news, the company touched on how it planned to increase revenues and realize additional cost savings. Dell also reiterated its commitment to its direct-sales model.

Let's take a look at some of the goals expressed at the meeting and how the company plans to achieve them.

Doubling revenues. While Dell pointed to the same factors contributing to future growth as it has in the past, its strategy seems a little more targeted this time around. Dell continues to look toward bolstering its presence in the enterprise business -- and in overseas markets -- for opportunities to double its revenues over the next four to five years. This includes its services business, a segment in which Dell says it could make a small acquisition. Dell has been consistent in articulating this strategy for some time and has made progress by gaining market share in services.

Dell also showcased some new server products to better meet customer demands in the enterprise market. It joined Hewlett-Packard and Compaq in offering "blade" servers. (A blade server is essentially a single motherboard containing the central processing unit, memory, networking, and associated electronics. The blades are stacked in a chassis to allow very dense computing power.) Dell said the new products provide higher performance.

The company also announced plans to roll out "brick" servers, which have more computing power than blade servers but are modular in nature and offer greater flexibility in computing environments -- giving customers the ability to dynamically size computing capacity as needed. These are important product introductions, and Dell should be able to compete well in these server categories. According to market research firm Yankee Group, the blade server market is expected to grow to $3.5 billion in 2005, from $150 million this year.

Cutting $1 billion-plus in costs. In the current fiscal year, Dell expects to top the $1 billion in cost savings it achieved in fiscal 2002. While a majority of last year's cost savings were from headcount reductions and steamlining facilities, in fiscal 2003 Dell intends to achieve further savings by shifting certain operations to low-cost sites, improving product design, and through supply-chain management programs.

As it did last year, Dell expects to pass along some of the savings to customers -- i.e., get more aggressive on pricing to gain market share. This strategy was highly successful in the most recent fiscal year: Dell's worldwide PC unit shipments grew 15%, while its three largest competitors posted an average decline of 12.3%.

Dell also noted that 25% of the cost advantage it enjoys over its peers had to do with its ability to move inventory rapidly and the leverage it gets from falling component costs. While these prices no longer are declining at the accelerated rate of 2001, Dell still has a significant cost advantage. This helped it post operating income of $2.3 billion in 2001, while its main competitors primarily lost money in PCs.

HP-COMPAQ IMPACT. Dell didn't resist the opportunity to talk about the proposed HP-Compaq merger. It noted that its win ratio -- a measure of its success rate in the bidding on contracts -- has recently improved to 80% from roughly 70%. According to Dell, customers selected its products for two reasons. One is that the HP-Compaq proposal created uncertainty among its enterprise customers, and they opted for Dell as a more stable choice.

Second, it's the policy of many enterprise customers to select two vendors for their hardware needs. A fair number used both HP and Compaq, so the potential combination led many to choose Dell to ensure they maintained their two-vendor policy.

Dell chose not to comment further on its recent forecast of a recovery in demand for PCs among corporate customers beginning in the summer of 2002. It did say the upturn should happen in the second half, but that it would be gradual.

This is in line with S&P's model, and we've decided to maintain our current estimates on Dell. We expect it to post earnings per share of $0.77 in fiscal 2003 (ending Jan. 31, 2003) up 18% year-over-year. With the shares trading at a price-earning of about 35 times that figure, we view Dell as fairly valued and rank the shares 3-STARS (hold). Analyst Graham-Hackett follows computer hardware and networking stocks for Standard & Poor's


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