Marcial: Giving Dell Its Due

While Wall Street pros are split almost down the middle over the merits of personal computer giant Dell (DELL), investors are clearly in the negative camp. According to data from Bloomberg, 16 analysts recommend buying Dell's shares, 16 rate it a hold, and two advocate selling the stock. Meanwhile, the shares have been hammered, to 11 from a 52-week high of 26 on Aug. 28. In 2006, Dell traded as high as 42.

Is the pounding justified? To some observers, it's overdone.

"We continue to believe the market underestimates Dell's ability to improve its revenue mix toward higher-margin enterprise sales," argues Kathryn Huberty of Morgan Stanley (MS), who rates Dell overweight. The company's revenues and gross margins showed signs of stabilizing in its most recent quarter, she says.

Huberty is confident about the outlook for Dell. She thinks the company is poised for higher earnings when corporate spending returns because of its stripped-down cost structure. With the PC maker holding $4 of net cash per share and maintaining stable margins, Dell's "valuation remains compelling," she notes. Aside from the company's cost-cutting efforts, says Huberty, Dell's positive cash flow of $761 million during the past quarter, vs. Morgan Stanley's estimate of $566 million, was a nice surprise.

bears fear weak industry demand

The big worry about Dell revolves around the global slowdown, which bearish analysts believe will lead to a 16% drop in revenues in fiscal 2010, ending on Jan. 31. "Our sell recommendation reflects our belief that Dell's multiyear efforts to move into new territories and offer more variety in products and services will be slowed, but not derailed, by weak industry demand that we project for the next three quarters," says analyst Thomas W. Smith of Standard & Poor's, who sees shares dropping to 9.50 in 12 months. (S&P, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP.)

The bulls believe Dell has adequately streamlined its business model to combat such a situation. "The important elements of Dell's return to earnings growth have been put into place," including raising the percentage of products whose production costs have been cut, says Richard Kugele, tech analyst at investment bank Needham. Demand for Dell's products has held up well, he notes. The company is now positioned to benefit from an impending catalyst—the arrival of Microsoft's (MSFT) long-awaited Windows 7 operating system in October 2010.

Kugele says investors shouldn't buy Dell shares just because its business has stabilized, or that it has slashed costs, or that gross margins stand at 18%. The most important reason to own the stock, he emphasizes, is the company's huge presence in the corporate market. That puts Dell "in the sweet spot of the PC-refresh cycle," which involves enterprises replacing their 4- to 7-year-old PCs with new ones that will operate on the new Windows 7 system, he says.

managing expenses well

Users are waiting for Windows 7 before refreshing or replacing their systems. Only a third of Windows PC users, Kugele notes, bought Microsoft's Vista system after its January 2007 release, with the bulk sticking with Windows XP or earlier versions. "There will be a surge toward Windows 7," says Kugele, which will be a big boost to Dell particularly because of its original design manufacturing (ODM) platform, which tailors PCs to the specific needs of corporate clients. Dell, he notes, outsources the production of such products, resulting in more cost-efficient and streamlined PCs, as well as handsome margins for Dell.

Kugele figures Dell will earn $1.04 a share in 2009 and $1.36 in 2010, up from $1.12 in 2008.

Dell's stock has dropped to ridiculously low levels, says Amitabh Goel, tech analyst at research firm First Global, who has upgraded his rating on the stock to market outperform from neutral. He says signs of a macroeconomic recovery indicate a revival in Dell's end markets, so the stock looks cheap at about 9 times the firm's 2009 earnings estimate—its price-earnings ratio has ranged between 7 and 36 in the past five years—and at 4.8 times book value.

Goel notes that although the environment remains tough, Dell should benefit from more stable demand as economic indicators improve and business confidence returns. He says Dell has been managing its expenses efficiently, helping ease pressure on the company's bottom line.

Sales also will be helped by demand from emerging markets, including China and India, he adds. And as more countries launch stimulus packages to boost their economies, the overall business environment for Dell will improve significantly, figures Goel.

No doubt a global economic recovery should deliver good fortune for Dell. At the stock's currently depressed price, investors could rack up some nice gains in the months ahead.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.