All's not well with Dell
Stock Spotlight: Can the No. 1 PC maker turn its stock price around in the face of slowing growth?
By Amanda Cantrell, CNN/Money staff writer

NEW YORK ( - Not so long ago, Dell Computer looked like a lean, mean, profit-making machine with seemingly unstoppable growth potential thanks to its famously efficient direct-to-consumer model.

Times have changed. Falling PC prices and increased competition from resurgent rival Hewlett-Packard have caused Dell to issue disappointing sales outlooks for the past two quarters. Dell (Research) stock tumbled 28 percent last year while shares of HP (Research) soared 38 percent on the heels of a major restructuring under new CEO Mark Hurd.

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Seven Wall Street analysts have cut their ratings on the stock since November, and some long-time institutional investors are weighing whether or not to dump the shares.

Investors and analysts will no doubt anxiously await results for Dell's latest quarter, due Feb. 16, to see if the computer maker can meet Wall Street targets of $14.8 billion in sales and earnings of 41 cents a share.

So is Dell still a fundamentally solid company whose shares are now attractively valued? Or will its slowing growth keep the stock in the dumps for years to come?

Dell's fresh hell

Dell used to have such a reputation for dependably meeting or beating its numbers and raising guidance that many investors jokingly accused Dell of being boring.

But starting in its fiscal 2006 second quarter, investors learned that boring is better than disappointing. The company missed revenue forecasts and said it got too aggressive in pushing low-cost desktops. More troubling, Dell lowered sales guidance for the third quarter and subsequently did so for the fourth quarter as well.

Investors had come to expect annual sales growth rates of 15 percent for Dell. Now analysts expect Dell to report a sales increase of just 11 percent in the fiscal year that ends in January 2007. So some think the stock's sell-off was justified.

"This was a leader but it's out to pasture," said Bob Bacarella, portfolio manager of the Monetta Fund, which does not own Dell. Bacarella added that the stock's drop hasn't made it any more appealing. "It can stay cheap for a very long time," he said.

Tony Ursillo, stock analyst for the Loomis Sayles Research Fund, said it is reasonable for investors to wonder if sales growth could drop below 10 percent, and fairly soon. "Coming into 2005, the thought was it's an 18 to 20 percent growth company. Now the question is whether they are going to dip below 10 percent," he said. The Loomis Sayles Research Fund does not own shares of Dell.

And FTN Midwest Securities analyst Bill Fearnley Jr., one of the analysts who downgraded the stock, said falling PC prices are not going away, since HP, Acer and Lenovo are all aggressively cutting prices.

Looming competition

The resurgence of HP is a problem for Dell on many fronts. HP competes with Dell not only in PCs, but also in printers a newer business for Dell as well as servers.

In addition, some say Dell's allegiance to Intel (Research) chips has enabled HP to gain ground in servers, since some HP servers use AMD (Research) chips, which many in the industry believe to be technically superior to those made by Intel.

HP's profit margins do lag Dell's -- HP was at 5.4 percent for fiscal year 2005 versus 6.5 percent for Dell in the first three quarters of its current fiscal year. But HP has a broadly diversified mix of businesses, which could give it an advantage over Dell going forward, particularly with larger corporate customers.

Some Dell investors say the company needs to focus on achieving the right mix of products and gain share in its non-PC businesses, such as storage, services and servers, so it can become less reliant on the maturing PC business, which accounts for 66 percent of Dell's sales.

"They've built the business around the PC and until these newer areas get bigger, they'll have to live with the anchor of a slowing PC market growth rate," said Ursillo at Loomis Sayles.

Mixing it up for growth

Certainly, Dell is facing some headwinds. But management has been making moves to turn things around.

In an e-mail to employees, CEO Kevin Rollins said Dell's second quarter was a "wake-up call," and he outlined a plan to get Dell back on track. That plan included shifting Dell's product mix to more higher-priced PCs, servers, storage and services.

Rollins also called for improving customer service and redesigning the sales and support areas on Dell's Web site. (Dell would not comment for this story, citing securities laws that prohibit it from speaking publicly about its finances just before it announces earnings.)

Dell is also making moves to expand its international presence, including Asia-Pacific and Japan. Sales outside the U.S. accounted for 40 percent of Dell's total in the third quarter. But gaining share in these areas will take time, as Dell will have to go up against regional competitors entrenched in those markets.

Analysts and investors agree that the stock isn't going to skyrocket overnight. But is it cheap enough to make it attractive for longer-term investors? Chirag Vasavada, a hardware analyst for money management firm T. Rowe Price, thinks so.

"If I was a new buyer I'd think this was a steal," said Vasavada, whose firm owns shares of Dell in its portfolios. "Dell is fundamentally well-positioned and improving its operations."

Mike Morcos, a portfolio manager at Aurora, Ill.-based Old Second National Bank, agrees, noting that with Dell currently trading at just 18 times estimated 2006 earnings, the stock is attractively priced.

His firm does not currently own shares of Dell, but he is considering adding the stock to his firm's portfolios. Morcos thinks it could hit the mid- to upper-$30s in the next 18 months, up from a recent price of about $31.50, if it can maintain current profit margins and grow revenues at 9 to 10 percent.

But Ursillo of Loomis Sayles is less optimistic. He notes that while 10 percent sales growth is "nothing to sneeze at" for a company of Dell's size, he's still wary. "We're in no hurry to embrace it," he said.

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FTN's Fearnley does not own shares of Dell, but his firm makes a market in the stock. Top of page

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