By Megan Graham-Hackett
Anecdotal evidence suggests that back-to-school sales of personal computers were lackluster at best. A number of semiconductor companies have lowered their outlooks based on slower-than-expected computer sales during the third quarter. Also, the reduced sales and earnings forecasts reported by RadioShack (RSH ) and Best Buy (BBY ) suggest that PC sales were disappointing.
One reason for the drag may have been excess inventories in the early summer resulting from the May merger of leading vendors Compaq Computer and Hewlett-Packard. True, PC unit sales are up in the third quarter from the previous one, but signs that the growth is only muted have spurred forecasts to come down across the board. Market research firm International Data Corp. (IDC ), based in Framingham, Mass., just reduced its worldwide PC-unit growth forecast to 1.1% this year and 8.4% in 2003, from earlier estimates of 4.7% and 11.1%, respectively.
At S&P, we weren't surprised by IDC's reduction because we felt its prior forecast was too aggressive. Our estimate at S&P has been for unit-sales growth of just 0.3% for 2002 and 6.6% for 2003. This assumes a gradual economic recovery and a lag between that and an upturn in information-technology (IT) spending.
IDC's outlook followed an equally bleak call by Intel (INTC ). The chip giant recently commented that it expects the third-quarter seasonal rise in PC unit sales to be weaker than normal. Furthermore, Intel warned that it doesn't expect much of a boost during the fourth-quarter holiday-buying season. Fellow chipmaker National Semiconductor (NSM ) also noted that a weak backlog for computer chips suggested a lackluster seasonal upswing at best.
With 2002 largely written off, the next likely debate will be whether a PC upgrade cycle surfaces in 2003. As noted, S&P is looking for 6.6% unit growth next year. While our outlook is for gradual growth, some catalysts may spark higher sales. For one, inventories have fallen -- and are now in pretty good shape -- from levels seen earlier in the summer, even though sales rose at a slower than expected pace.
In addition, many recent surveys of chief investment officers and IT professionals indicate that one of the areas targeted by tech budgets is new computers. An upgrade cycle, though, depends largely on the corporate earnings picture. If earnings growth in general improves by the second half of 2003, an upgrade cycle is likely.
But if corporate earnings continue to be disappointing, IT spending probably won't pick up. And without knowing exactly when earnings will improve enough for companies to open their wallets, it's hard to tell whether demand for new hardware will come mostly in one quarter, or if it'll be spread out over several.
Also, it's not clear if PC makers can benefit from new spending when pricing competition is so stiff. Computer manufacturers have been cutting prices to stimulate demand and gain market share. Those low prices may continue to crimp revenue. Plus, even if the number of PCs sold rises 8.4% in 2003 as IDC projects, PC makers could still lose money because the volume won't be sufficient to offset costs.
Given this lackluster outlook for profit growth in the PC sector, we remain neutral on many names, including Apple (AAPL ), Dell (DELL ), Gateway (GTW ), and Hewlett-Packard (HPQ ). All of these stocks carry an S&P ranking of 3 STARS (hold).
Analyst Graham-Hackett follows computer hardware stocks for Standard & Poor's