Predictions for PC Makers

Price wars will pressure profits among the big players, says S&P's Megan Graham-Hackett, who has a neutral outlook overall for the group

Although some technology stocks have staged a nice rally recently, computer hardware has lagged behind the market for the year. Year-to-date through Dec. 2, the S&P Computer Hardware index rose 1.4%, vs. the 4.4% gain in the S&P 500-stock index.

This marks a reversal of a trend established late in 2004, as investors felt enthusiastic about the strong computer demand during last year's holiday season and helped push computer hardware stocks to a 13.7% gain for the year, compared with the S&P 500's 9% rise.

FIGHTING FOR SHARE.

"It has been a rather long cycle for a PC refresher cycle," says Megan Graham-Hackett, who follows computer hardware stocks for Standard & Poor's Equity Research. She figures unit growth will come in around 15% this year, but then she sees the rate slowing to 9% in 2006.

Graham-Hackett has a neutral fundamental outlook for the computer hardware group, and she has a hold recommendation on shares of Apple (AAPL), Dell (DELL), Hewlett-Packard (HPQ), IBM (IBM), and Sun Microsystems (SUNW).

She continues to see signs of steady demand for technology products, given the need for companies to produce more due to a competitive global market and the growing use of the Internet. But her enthusiasm is tempered by the potential for difficult comparisons for hardware growth rates in 2006 and continued pricing pressure as vendors fight for market share.

"SELF-HEALERS."

Given that this pressure has remained intense, hardware vendors are trying to offset the negative impact on profits by offering services, servers, and storage that carry wider margins, Graham-Hackett says. In particular, she says hardware companies are focusing on automated and "self-healing" features and single-button functions.

BW Online's Karyn McCormack recently spoke with Graham-Hackett about what hardware companies are doing to boost sales. She also discusses her stock picks. Edited excerpts from her remarks follow:

Note: Megan Graham-Hackett is an S&P Equity Research analyst. She has no ownership interest in or affiliation with any of the companies on which she writes research. All of the views expressed here accurately reflect the analyst's personal views regarding any and all of the subject securities or issuers. No part of the analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed.

What are the next-generation hardware products to look for from the major computer companies like Sun, Hewlett-Packard, and IBM?

For the corporate side, the major category for computer hardware companies would be servers. The focus is on ways to improve the return on capital outlays for these servers. Companies are looking for automated features, to almost self-diagnose if some kind of fault occurs.

This helps give companies better response time and better processing -- and essentially helps companies streamline their staff. That's where the industry has evolved over the past couple of years, introducing features that had been the domain of mainframes and offering what's been described as "self-healing" features. Sun has introduced products in this area (see BW Online, 12/7/05, "Sun's Super Servers"), and so have HP and IBM. They're all pretty much going after the same market.

At the same time, the industry has always focused on faster and cheaper devices. As corporations have deployed a horizontal architecture in their data centers, the issue has been heat dissipation.

In data centers, companies have a lot of smaller servers stacked in a rack-mounted chassis.