Dude, is There any Value Left in Dell?

By Chad Henage - April 2, 2012 | Tickers: AAPL, DELL, EMC, HPQ | 0 Comments

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I remember when Dell (NASDAQ: DELL) was the model of efficiency in the PC industry. The company was one of the first to pioneer the build-to-order computer. Dell also was a high-flying stock that could do no wrong. Michael Dell became a well-known face in the computing industry, and the stock rose from under $1 (split adjusted) to over $50. The problem is it's not year 2000, and Dell's stock, which peaked at $53.94, trades for just $16.67 a share today. The moral of the story: You have to know why you own a company, what is changing in the industry, and adjust accordingly.

Fellow fool Rich Smith, recently wrote an article about how he felt that Dell could be a good value at today's prices. His expectation was Dell has a very low bar to jump over, and even if the company just does okay, the stock could be a good buy. What I want to do is dig into Dell's numbers to see if the stock looks attractive. I also want to see how Dell's offering stack up against their competition. Then I also want to look at what Dell could be missing.

I. Dell's Numbers

The stock currently trades at $16.67, which gives the company a forward P/E of 7.83. Dell is not expected to show tremendous growth, as analysts are only expecting 5.84% growth going forward. There are two positive factors working in Dell's favor. First, analysts have raised 2012 and 2013 earnings expectations in the last 90 days. The second positive I see is, the company has been beating analyst estimates by a decent margin. Even including the most recent miss, the company beat earnings expectations 3 of the last 4 quarters, by an average of 12% per quarter. The biggest risk to Dell's future earnings is the bleak expectations for revenue growth. The company is expected to show average revenue growth of just 1.15% over the next two years. On a positive note, Dell's cash flow shows a much better picture.

In the last four quarters, the company generated $4.85 billion in free cash flow. The company obviously thinks its stock is cheap, because it repurchased $2.68 billion worth of stock in the last year. This free cash flow has added to Dell's balance sheet. The company has increased its net cash position in the last four quarters from $9.57 billion to over $13 billion.

II. Dell's Competition

Dell competes in multiple markets for computer buyer's interest. The company competes with Hewlett-Packard (NYSE: HPQ) in retail, small business, and servers. Fortunately for Dell, HP can't seem to get out of its own way. HP has seen cash from operations decline sequentially in the last 4 quarters. So while Dell generates $0.11 of free cash flow per $1 of assets, HPQ generates just $0.05 of free cash flow per $1 of assets. Clearly HPQ is having problems, but Dell can't assume those will continue indefinitely. Dell also competes against companies such as EMC Corporation (NYSE: EMC) in the server field. With EMC expected to grow by over 15% in the next few years versus Dell expected to grow at under 6%, clearly EMC is taking advantage of its leadership in the server arena. No list of competitors would be complete without mentioning Apple (NASDAQ: AAPL). Dell competes against Apple in desktops, laptops, and small servers. However, Dell also competes in the tablets market, since some customers are choosing tablets over traditional PCs.

III. What Could Dell Be Missing?

There are several steps that Dell can take to improve the company's competitive position. I've noticed that Dell still offers basically the same desktops and laptops that they did 5 years ago. I still see the Inspiron name with the same black plastic casings for home use. I still see the XPS series that was supposed to be Dell's answer to Macbook offerings from years ago. The only new offering I see on the laptop side, is the XPS 13 Ultrabook. Clearly this is a shot across the bow at the Apple Macbook Air. Here is the problem, machined aluminum is something Macbook Air has had for years. A thin laptop with an edge-to-edge glass display, is also a Macbook Air standard. Dell needs to come up with their own ideas, and make their Ultrabook different in some way. When CNET says, “Dell finally gets into the ultrabook game...” that is not a compliment.

The company doesn't appear to innovate, they copy other ideas well after other companies have taken the first-mover advantage. To be blunt, Dell needs to move faster. When Dell sees a successful category like tablets take off, they need to be there. The fact that Dell doesn't have a tablet design already in production puts the company at a huge disadvantage. While Apple is selling 3 million iPads in 3 days, Dell is selling exactly none. In the computer industry a lack of innovation, and slow movement is a competitive disadvantage that can be near impossible to overcome.

Dell needs to simplify its choices. The be honest, this is the one place where copying your competition is okay. Look at Apple's online store, and then compare this to Dell's online store. Apple offers 2 laptops, Macbook Air and Macbook Pro. Dell offers two different types of Inspiron laptops, with 5 total models. The company offers XPS laptops in two models plus the Ultrabook. They offer 3 different Alienware laptops for gamers, and that is all just on the “For Home” shopping page. This one comes down to simple quality choices versus quantity of choices.

Dell should pay a dividend. With $4.85 billion of free cash flow in the last 4 quarters, and about $2.7 billion in share buybacks, the company still added $2 billion to its investments last year. With 1.76 billion shares outstanding, a dividend of $0.50 per share would use about $880 million in cash. Without the share repurchases this would give the company a free cash flow payout ratio of just 18%. This $0.50 per share dividend would generate a yield of 3%, which would diversify the buyers of Dell stock, and give existing shareholders a reason to be a little less frustrated with the basically flat stock price of the last three years.

Conclusion

Dell could be attractive at these levels, if the company paid a dividend. With no dividend, a company that is expected to have anemic revenue growth, and earnings growth of less than 6% is just not a stock I would buy. With an 18% payout ratio that would generate a 3% yield, the company could obviously afford to pay a dividend and would have room to raise this payout. Until Dell institutes a dividend or shows drastic improvement in their innovation, I would avoid the shares.

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