In Dell's (Nasdaq: DELL) most recent quarter, non-GAAP EPS jumped 89% year over year. With the stock trading at a paltry forward P/E ratio of 9.3, is it a great buy? Or is this a big value trap?
Decelerating revenue growth and waning cost savings
Dell faces some tough headwinds in the coming quarters. Revenue growth is slowing, and the company faces tough comparables for the next three quarters. For the coming fiscal year (2012), management expects revenue growth of only 5% to 9% -- a significant slowdown from 16% last fiscal year.
Management guided operating income growth to only 6% to 12% for fiscal 2012, compared with an adjusted (Non-GAAP) 40% growth in fiscal year 2011. With operating income expected to grow only 1% to 3% above revenue, and sensitive to volatile component costs, investors should question how much cost efficiencies could continue driving EPS growth.
The end of easy comparables
The recession hit Dell hard. Its dependence on cyclical computer hardware sales didn't help. But the harder they fall, the higher they bounce. That, coupled with the $3.9 billion acquisition of services provider Perot Systems in November 2009, contributed to impressive improvement in Dell's top and bottom lines last year. However, Dell's results aren't so impressive if you look at changes over the past two and five years.
|
Metric |
1-Year CAGR |
2-Year CAGR |
5-Year CAGR |
|---|---|---|---|
| Revenue |
16% |
0% |
2% |
| Gross Profit |
23% |
2% |
3% |
| Operating Expense |
12% |
1% |
8% |
| Operating Income |
58% |
4% |
(5%) |
| Net Income |
84% |
3% |
(6%) |
| EPS (Diluted) |
85% |
4% |
(2%) |
Source: company reports.
Core business stagnating
Think Dell's core hardware business is stagnating? Then you hit the nail on the head. Over the past two years, Dell's revenue in the hot mobile sector increased bya measly 2% as Apple's (Nasdaq: AAPL) iPhone and iPad stormed the market. Dell's revenue in the high-growth, high-margin storage sector declined -- yes, declined -- by an unfathomable 14%. Meanwhile, revenue at storage providers EMC (NYSE: EMC) and NetApp (Nasdaq: NTAP) increased by 14% and 82%, respectively, over roughly the same time frame. Excluding services, where the Perot acquisition was the main driver of 43% growth, Dell's revenue growth has actually been slightly negative.
|
Segment Revenue ($ millions) |
FY09 |
FY11 |
2-Year Change |
|---|---|---|---|
| Mobility |
$18,604 |
$18,971 |
2% |
| Desktop PCs |
$17,364 |
$14,685 |
(15%) |
| Software and Peripherals |
$10,603 |
$10,261 |
(3%) |
| Servers and Networking |
$6,512 |
$7,609 |
17% |
| Services |
$5,352 |
$7,673 |
43% |
| Storage |
$2,666 |
$2,295 |
(14%) |
| Total |
$61,101 |
$61,494 |
1% |
| Total Ex-Services |
$55,749 |
$53,821 |
(3%) |
Source: company reports.
Alas, Dell doesn't report operating income by segment. There's a likely reason that management doesn't make this information available.
Increasing expenses and tax rate
Net interest and other expenses are expected to increase to $240 million this fiscal year. Moreover, management expects Dell's tax rate to rise from a multiyear low of 21.3% last fiscal year to 23% to 25% this fiscal year. Both will pressure EPS growth.
Are estimates too high?
The consensus estimate for the current fiscal year looks optimistic. Dell didn't offer EPS guidance. Instead, it gave guidance for operating income growth, other income and expenses, and tax rate. Let's do the math.
|
Metric |
Low End of Range |
High End of Range |
|---|---|---|
| FY11 Operating Income ($mm) |
$3,433 |
$3,433 |
| Y/Y Operating Income Growth (Guidance) |
6% |
12% |
| FY12 Estimated Operating Income ($mm) |
$3,639 |
$3,845 |
| FY12 Other Income and Expense ($mm Guidance) |
($240) |
($240) |
| FY12 Estimated Pre-Tax Income ($mm) |
$3,399 |
$3,605 |
| FY12 Tax Rate (Guidance) |
25% |
23% |
| FY12 Estimated Taxes ($mm) |
$850 |
$829 |
| FY12 Estimated Net Income ($mm) |
$2,549 |
$2,776 |
| FY12 Estimated Share Count (mm) |
1,915 |
1,910 |
| FY12 Estimated EPS |
$1.33 |
$1.45 |
Sources: company reports and The Motley Fool.
The estimated share count assumes that Dell continues spending $200 million a quarter on share buybacks, that the entire buyback goes to reducing the share count (instead of offsetting employee stock options), and that there's no change to the current stock price of $15.43. OK, it won't play out exactly this way. For perspective, we assume the share count drops by 40 million to 45 million in FY12, compared with only 7 million in FY11. Thus, the error could be on the optimistic side.
The Foolish FY12 EPS estimate of $1.33 to $1.45 is below the consensus estimate of $1.67. On a GAAP basis, analysts are high as well, projecting $1.55 in earnings. Maybe we’re missing something. Or maybe those Wall Street analysts are too busy spending big post-TARP bonuses to sharpen their pencils. Or perhaps they don't want to lower forecasts on a "buy"-rated stock. To be sure, Wall Street estimates range from $1.44 to $1.87, encompassing our range.
Even if the $1.67 consensus estimate is correct, it's calling for ho-hum EPS growth of 5% year over year.
Long-term outlook
But hey, the stock is trading at a forward P/E ratio of only 9.3. What about the long-term outlook? Management's "long-term value-creation framework" calls for operating income growth of "7+%," with revenue growth of ">5 to 7%" helped by "strategic alternatives."
"Strategic alternatives" is a fancy word for acquisitions, and Dell has a reputation for paying up. It has more than $14 billion in cash and equivalents to continue funding its expensive shopping expeditions. That said, overpaying could run down that cash level, particularly since operating cash flow increased by a wimpy 2% year over year in the most recent quarter and fiscal year. Weak cash-flow growth could also dampen the company's ability to boost EPS through share buybacks.
Foolish takeaway
Dell looks more like a value trap than a screaming buy. A better value in the computer sector is IBM (NYSE: IBM), which is forecasted to grow EPS by 13.5% year over year, offers a 1.6% dividend yield, and is trading at a forward P/E ratio of 12.6.
More on Dell:
- Dell Shares Popped: What You Need to Know
- Dell's Adamo Saga Shows Why the Stock Isn't Rebooting
- Is AMD for Sale?
See a stock in this story you'd like to follow? Add it to My Watchlist, which will find all of our Foolish analysis on it.
