"Our business model adapts quickly to economic changes, even the kind of significant challenge we saw in the third quarter." -- Dell CEO Michael Dell
Sing it, brother. In its earnings released last week, Dell (NASDAQ:DELL) managed to report the complete opposite of what analysts had expected -- but from where I sit, Mr. Dell has it exactly right.
Three months ago, as you may recall, I lamented Dell's attempt to sell lots of stuff at horrible margins. In trying to undercut Hewlett-Packard (NYSE:HPQ) and Apple (NASDAQ:AAPL) on price, Dell was selling plenty of computers, sure -- but its profits were dwindling in consequence. So I was just pleased as all get-out to see in last week's report that Dell's lower-cost initiatives appear to be working.
The news
- Sales in the fiscal third quarter dropped 3%.
- And yet, "rigorous cost management" (Dell's words, this time) helped the company boost its operating margin on those sales by 160 basis points to 6.7% from last quarter.
- Result: In a declining sales environment, and one of the biggest global recessions on record, Dell got its profits rising again -- up 9% to $0.37 per share.
Now it's worth noting here, too, that Dell isn't shooting itself in the foot by raising prices just to get the better margins, hurting sales in consequence. Actually, sales by unit did grow in Q3 -- by 3%. It's only sales as measured by dollar value that dropped -- so Dell's keeping up its end of the price war with its rivals. Incidentally, cheaper Dell computers should also go a ways toward keeping consumer demand up -- which should be good news for Dell retailers Best Buy (NYSE:BBY) and Wal-Mart (NYSE:WMT).
Valuation
But let's get down to brass tacks. Yes, I think Dell did swell. But times are tough and the company's continued performance is by no means certain. Considering the risks, is the stock worth owning today?
I really wish I could give you a clear "yes" vote on this one, but I can't. Here's why:
So far this year, Dell has generated around $764 million in free cash flow. At that rate through the end of the year, that would work out to about $1 billion -- and a price-to-free cash flow ratio of 20. To me, that seems a bit rich relative to the company's anticipated long-term growth rate of 10%. At this price, with these prospects, in this sales environment, I just can't countenance buying Dell. This one looks like no more than a hold.
