Over the past decade, few companies have performed as strongly as Motley Fool Stock Advisor pick Dell (NASDAQ:DELL). The computer purveyor has been a model of efficiency, mastering the process of assembling and selling PCs while maintaining torrid growth. Those investors who had the foresight (or luck) to invest in the early '90s and hang on have been richly rewarded.
Just because Dell has been consistently excellent (even boring) over the years doesn't mean that problems can't arise. Actually, I think Dell's story is getting more interesting now, and I've found some issues that I believe bear watching.
Accounts receivable and inventory growth
Much has been written at the Fool about the dangers of excessive inventory and accounts receivable growth. An investor who monitored inventories and accounts receivable would have known something was amiss at Cisco Systems (NASDAQ:CSCO) in the summer of 2000 when the stock was still selling in the 50s or 60s -- about three times the current share price. Furthermore, an inventory buildup last year at semiconductor firms such as Intel (NASDAQ:INTC) preceded sharp declines in stock prices.
Digging into Dell's financial statements shows that accounts receivable have grown by 54% over the past two years and inventories have grown by 59%. In comparison, sales are up by just 37%.
Of the two, I'm less concerned about the inventory situation. Inventories have been growing as Dell sells new products like plasma and LCD TVs and expands its business worldwide. The eventual size of Dell's inventory will probably depend upon the agreements it negotiates with its new suppliers, but given Dell's stature, it seems likely that the arrangements will be favorable. It's also worth remembering that inventories are still only a tiny fraction of quarterly sales. Dell turns over its inventory every five days -- an amazing feat for a company of its size.
The accounts receivable increase, on the other hand, is more worrisome. We'd like to see accounts receivable growing at the same rate as both sales and accounts payable, but that's just not the case. Accounts payable have grown by 43% over the last two years -- more than sales, but less than the increase in receivables.
I can think of two explanations for the growth in accounts receivable, the first being that Dell may be offering overly generous payment terms to customers in order to drive sales. The second possibility is that a large fraction of the quarter's sales may be occurring during the final few weeks of the quarter. During the conference call, Dell's CEO Kevin Rollins claimed that July was a strong shipment month, which would indicate the second explanation (provided his statement was convincing, which it is not).
The table below shows the year-over-year increase in accounts receivable for the past eight quarters. In every quarter, accounts receivable growth has outpaced sales growth by a wide margin. In other words, this is not a single-quarter phenomenon, so claiming that July sales were strong just doesn't address the real problem.
Dell Year-Over-Year Growth Rates
|
Quarter Ended |
AR Growth |
Sales Growth |
|---|---|---|
|
10/31/2003 |
18.10% |
16.20% |
|
1/30/2004 |
41.80% |
18.30% |
|
4/30/2004 |
28.90% |
21.10% |
|
7/30/2004 |
25.70% |
19.70% |
|
10/29/2004 |
32.60% |
17.70% |
|
1/28/2005 |
21.30% |
16.90% |
|
4/29/2005 |
25.30% |
16.00% |
|
7/29/2005 |
22.60% |
14.70% |
Growth in accrued and other liabilities
Accrued and other liabilities represent items like deferred revenue and warranty liabilities. These liabilities have jumped sharply by 33% over the last year and 82% over the last two years. Although the accounting for these liabilities may seem difficult, it isn't all that bad. Here's how it works:
When you buy a warranty on a Dell computer, Dell makes an educated guess of the eventual cost of servicing that warranty, which is recorded as a warranty liability on the balance sheet. The money Dell receives up front for the warranty is recorded as deferred revenue and is amortized over the life of the warranty.
So why has this liability been growing much faster than sales? Dell may be aggressively pushing their customers to buy warranties. This offers the benefit of helping to maintain Dell's growth rate if PC demand is stagnating. It would also help explain how Dell has been able to maintain such strong growth in an environment where corporations are reluctant to spend and their competitors like IBM (NYSE:IBM) and Hewlett-Packard (NYSE:HPQ) have struggled. The problem is that servicing the warranties will eventually cost Dell money, and it's always possible that Dell is underestimating the cost of warranty service.
None of these issues is alarming at present, but big problems usually start out small. And don't expect the CEO to call and tell you to sell if things start to fall apart. There can be little debate that Dell is superbly managed, but there are new risks now that Dell is adding so many new products and expanding worldwide in order to keep its growth rate up. Even great companies sometimes stumble. Is that in the cards for Dell?
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Fool contributor Dan Bloom doesn't own shares of any stock mentioned in this article. He welcomes your feedback at [email protected].
