Investors Overlook Dell's Down Quarter

Despite a 48% drop in fiscal fourth-quarter profits, Dell's shares rise in after-hours trading on optimism about cost-cutting

By Aaron Ricadela

Cutbacks in computer buying chopped Dell's fourth-quarter profits nearly in half from a year earlier. But investors lifted the PC maker's stock in extended trading after the dour news was released on Feb. 26, amid optimism that aggressive cost-cutting will make Dell more competitive once the economy recovers.

Dell (DELL) sales fell 16%, and net income dropped 48% during the quarter ended Jan. 30, numbers that missed Wall Street's already-reduced expectations. Yet Dell said it plans to slice an additional $1 billion a year out of its annual expenses within two years, accelerating an existing cost-cutting plan and heartening investors who want Dell to compete more effectively with its chief rivals, Hewlett-Packard (HPQ) and Apple (AAPL). "The way we're running the business is around operating income and cash flow," CEO Michael Dell said during a conference call with analysts.

Investors are buying Dell shares on the hope that slimming down now will leave the company in good stead when the economy recovers and buyers open their wallets, says Avi Cohen, head of research at Avian Securities. "As you buy the stock today, you're buying recovery potential," he says. "Stocks haven't been moving based on what the reported numbers are. They're much more sensitive to general economic numbers and the health of a company's business going forward."

Worst PC Market in Years

Shares of Dell rose 15¢, or 1.8%, in extended trading, erasing the earlier decline that left the stock at 8.21 when markets closed. The shares have slumped almost 20% in 2009, and have lost more than two-thirds of their value in the past six months.

Dell and other computer makers are facing the worst PC market in years. HP on Feb. 18 reported a 19% drop in PC sales for the quarter that ended Jan. 31. Sanford C. Bernstein analyst Tony Sacconaghi said in a Feb. 24 research note that he now expects PC sales to decline 7.3% this year, compared with a previous forecast of 4.9% growth. Sales of servers that run Web sites and corporate networks have weakened as well.

As companies and consumers cut back on computer buying, Dell is taking an even bigger ax to costs. The company reduced operating expenses by 16%, or $363 million, in the quarter. That's faster than the 11% decline in Dell's third quarter.

More Aggressive Cost-Cutting

Chief Financial Officer Brian Gladden told analysts Dell now expects to reduce its annual expenses by $4 billion a year by January 2011, a steeper reduction than its previous goal of $3 billion. Dell has eliminated 9,300 jobs in the past year, and Gladden said more "streamlining the organization" is on tap. But he also said Dell is reducing the cost of the components that make up its products; its average cost per computer has fallen by 5% in the past year.

Manufacturing is getting cheaper, too. A quarter of the company's output now comes through contract manufacturers rather than Dell's own, more expensive factories. During the quarter, Dell announced it would close a factory in Limerick, Ireland, and move that site's production to Poland, eliminating 1,900 jobs.