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| Not so Dell-ightful: HP may be # 2 in the PC business but since firing Carly Fiorina, its shares have outperformed industry leader Dell's. |
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NEW YORK (CNN/Money) – Dell will report its fiscal second quarter results on Thursday. As usual, the world's top personal computer company is expected to report spectacular numbers.
Analysts are forecasting a 23 percent increase in profits, to 38 cents a share, and a 17 percent jump in sales, to $13.7 billion.
Those are incredible growth rates for a company of Dell's size. But that sound you're hearing right now from Wall Street is a resounding yawn.
Shares of Dell (Research) have fallen about 6 percent this year, which raises the question: Has Dell become a victim of its own success?
Wall Street sees potential in HP...
Dell's top rival in the PC business, Hewlett-Packard (Research), is in the midst of a dramatic restructuring. The company, under new CEO Mark Hurd, announced plans to slash 14,500 jobs last month in order to streamline HP's operations.
While HP is expected to post impressive year-over-year earnings gains of nearly 30 percent when it reports its fiscal second-quarter results on August 16, sales are only estimated to rise by 8.4 percent from a year ago.
But investors seem to be more intrigued by HP's cost-cutting than Dell's growth prospects. Since HP fired Carly Fiorina in February, its stock is up 23 percent while Dell's shares have dropped 4 percent.
Cindy Shaw, an analyst with Moors & Cabot Capital Markets, doesn't expect this trend to continue for much longer.
HP will still be able to find more ways to lower expenses in order to boost earnings over the next two years, she said. But Dell is the better bet because it already has a low-cost business model in place.
"It's two different stories. Dell is a well-oiled machine and HP is a turnaround," said Shaw. "Dell is my top pick."
Sooner or later, HP will need to address more than costs, adds Melanie Hollands, president of Koala Capital, a hedge fund specializing in tech stocks. It will also need to figure out how to generate stronger sales growth. That will be an even more daunting challenge.
"Dell has more longevity. It's less focused on how to fix itself and instead on how it can sustain revenue growth in the long-term," Hollands said. She does not own a position in either stock in her fund.
This is not to suggest that HP's shares a due to fall off a cliff, especially if Hurd works the same type of cost-cutting magic that he did when he was the CEO of NCR (Research).
But if demand for tech hardware -- PCs, servers and storage -- continues to improve, then it's hard to imagine a scenario where Dell's stock fails to participate in a rally.
...but Dell is the safer play
As a result of Dell's stock slump, the big premium that Dell has typically traded at (versus HP) has narrowed significantly. In fact, if you factor in Dell's substantially higher projected growth rate into the valuation equation, you can argue that Dell is the better bargain.
Dell trades at 24.6 times earnings estimates for this fiscal year, or 1.2 times analysts' long-term earnings growth forecast of 20 percent a year. HP has a P/E of 16.6 times fiscal 2005 estimates and is only expected to grow at a 10 percent clip for the next few years. So its price-to-earnings growth (PEG) ratio is nearly 1.7.
As long as Dell keeps delivering healthy gains in earnings, it's hard to justify this low a stock price. "Dell shares deserve a premium versus peers and the market due to above-market EPS growth," wrote Citigroup analyst Richard Gardner in a report Tuesday.
It seems safe to say that Dell could beat sales expectations and raise its guidance for its crucial third-quarter, which includes the back-to-school shopping season. After all, Dell's leading chip supplier, Intel (Research), reported record sales in its second quarter last month and issued third quarter revenue guidance that was ahead of consensus estimates.
Intel said that it was seeing particularly robust demand for higher-margin notebook computers as well as strength in emerging markets such as China and Latin America. Those are both good sign for Dell, which reported a 22 percent increase in sales of laptop computers in its second quarter and a 21 percent gain in sales of all products outside of the United States.
Even if Dell merely meets second-quarter targets and guides to an in-line third quarter, investors should not be disappointed. Analysts currently expect Dell to report another 17 percent increase in revenues, to $14.6 billion, for the quarter, and a 25 percent jump in earnings per share, to 41 cents.
Ultimately, it is this type of steady performance that makes Dell more attractive for an investor with a multi-year time horizon.
"Longer-term stock moves are all about growth," said Hollands. "Dell has less downside risk than HP. It's still the bellwether to own in hardware."
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Moors & Cabot's Shaw does not own the stocks mentioned and her firm has no investment banking relationships with the companies mentioned. Citigroup's Gardner does not own the stocks mentioned but his firm has done banking for Dell and HP.
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