Time To Click Onto Computers Again?

Only weeks ago, computer companies were surrounded by gloom and doom--and investors had reason to be wary. Inventories were overloaded, the home market was said to be played out, and overall demand for personal computers was turning sluggish. PC heavyweights such as Compaq warned of ho-hum first-quarter results.

Yet on Apr. 24, Compaq reported a stronger-than-expected revenue rise of 42% combined with an earnings hike of 8%. The stock climbed 31/8 on the news. A day later, Gateway 2000 posted a 31% rise in profits, exceeding Wall Street's expectations. The shares of chipmakers such as Intel as well as chief Compaq rivals Dell, Digital Equipment, and Hewlett-Packard also rode the rally.

USER-FRIENDLY. With all these conflicting signals, investors have to be wondering, what gives? For one thing, it appears that worldwide PC demand, which had been growing at an annual rate of 25% to 30% during the past three years, may not be slipping as badly as was feared. Current worldwide growth appears to be in the 17% to 20% range, slower for sure, but not alarming. "I think people are waking up to the fact that end-user demand was never that bad and should actually improve as we go through the year," says Todd Bakar, managing director of research at Hambrecht & Quist in San Francisco.

Meanwhile, analysts believe that computer makers are getting those inventories in check. "When the slowdown became obvious to the whole industry, the first step retail stores, distributors, and vendors took was to reduce their inventory levels," says Vadim Zlotnikov, a senior analyst at Sanford C. Bernstein in New York. Compaq's inventory dropped to $1.9 billion in the first quarter, down $221 million from the end of last year. Intel's levels fell to about $1.5 billion from just over $2 billion.

Certainly, caution is in order. Now that inventories are leaner and reorder rates are picking up, "the danger is we can see a repeat of last year, where the consensus view of an extraordinarily strong second half doesn't materialize," says Zlotnikov.

Looking forward, investors hoping to avoid such a scenario may want to concentrate on the companies that boast low inventory risk. They include Dell and Gateway, which sell directly to customers. "These companies build to order. They don't build to forecast, so they don't get stuck with this stuff," says Eugene Glazer, a technology analyst at Dean Witter in New York.

Gateway has been running television spots to increase its brand awareness, and it also recently unveiled Destination, the first combination large-screen TV and computer. The big question is whether Gateway's stock already reflects these developments: The day after its positive earnings release, the shares were battered back down by 9%.

Many analysts think Compaq's stock still has life to it. Beyond getting inventory in order, Compaq's server business has folks excited. Servers account for less than a quarter of sales but nearly half its profits. Compaq also plans to bring out a promising line of PC attachments developed with Fisher-Price and aimed at children, including an oversize kiddie keyboard and a driving toy.

The drive along AST Research's road is far bumpier. AST has been bleeding red ink lately. Now backed by a huge bank-credit guarantee from Samsung Electronics, which owns 40% of the stock, new AST CEO Ian Diery has laid out an ambitious plan to be first to market with products built around the latest technology. Diery claims, for example, that a notebook PC with a 133-Mhz Pentium processor will come out before a comparable Toshiba model. But "they're caught in a very difficult position," says Kei Yamamoto, assistant portfolio manager at Franklin Resources in San Mateo, Calif. For one thing, Diery's goal is shared by Dell and Gateway, which are more nimble. In addition, AST has been losing ground to relative upstarts in the PC business such as HP, which is a favorite of Yamamoto's.

The shares of Diery's alma mater, Apple Computer, must also be deemed a long shot, though there are a few developments the company is pinning its hopes on. The rise of the Internet plays more to Apple's strengths than those of other makers, says Dean Witter's Glazer, in part because Apple's computers are the dominant choice of graphic designers working on the Web. Still, Glazer and other analysts hesitate to recommend Apple's stock just yet. But as the computer industry has recently demonstrated, what looks gloomy today can brighten up a lot faster than expected.

Before it's here, it's on the Bloomberg Terminal.