Does a Huge Earnings Miss at Dell Inc. (DELL) Signal the End of the PC?

One of the biggest disappointments this earnings season came with the latest results from Dell Inc. (NASDAQ:DELL), which showed that the company’s profit dropped by a massive 79% during the fiscal first quarter (ending on May 3). Such a significant downside surprise is helping to discourage sector surveys, which show major declines in PC sales this year.  This creates a negative backdrop for Dell and its competitors, and with shares in Dell Inc. (NASDAQ:DELL) trading near their highs for the year the major earnings miss presents an interesting opportunity for short sellers looking to get bearish on the sector.

Weaker earnings for PC Makers

Dell Inc. (NASDAQ:DELL)’s latest report shows that profits dropped to $130 million, from $635 million seen in the same reporting period last year.  Revenue declined by 2% (coming in at $14.1 billion), with the weakness driven largely by PC sales, which were lower by 9% (coming in at $8.9 billion) for the quarter.  Operating profit for this division fell by 65% (to $224 million), with laptop sales another area of significant weakness.  There were not many encouraging data points in the report, but sales in both servers and network gear rose by 14%.  The company’s services division also saw revenue increase (by 2%).  Using a pro-forma basis (which eliminates one-time items), earnings were seen at $0.21 per share, well below the $0.35 per share Wall Street had anticipated.

Shareholder disputes

Dell Inc. (NASDAQ:DELL)’s negative earnings report comes as the company is undergoing well-publicized discussions with shareholders, in an attempt to take the company private.  CEO Michael Dell says this move would give the company extra time to position itself in new areas of the market (such as software and in mobile devices), without having to focus on the needs of shareholders.  Opposition to these plans has been voiced by two of the company’s largest shareholders (Carl Icahn and Southern Asset Management), based on the argument that Dell Inc. (NASDAQ:DELL)’s $24.4 billion of the company is not a true reflection of its worth.  These discussions have created extra costs for the company as well, contributing a reported $90 million in extra costs for the quarter.

Problems at the sector level

All of these negatives together must be viewed within the broader context of the PC industry.  According to data compiled by the International Data Corporation reports (IDC), sales in PC units fell by 14% (to roughly 76 million units) in the first quarter.  This is the biggest drop since the survey began tallying these figures, and is indicative of a wider consumer shift to tablets and smartphone devices.

Some of this weakness is being attributed to Microsoft Corporation (NASDAQ:MSFT)’s inability to generate market interest with its Windows 8 operating system.  One of the most common criticisms of this latest PC product offering from Microsoft is that it is actually better designed for tablets and other mobile devices, which does little to help the next round of earnings prospects for Dell and its competitors.

Weak Windows 8 sales cloud the picture for Microsoft Corporation (NASDAQ:MSFT) as well. For the first quarter, Microsoft’s Windows division posted no growth.  This has led Microsoft to hold off on releasing official sales figures, but the Windows division as a whole saw overall quarterly revenues of $5.7 billion.  When we adjust for revenues created by the substantial Windows 8 discounts made available in the first quarter, these numbers decline to $4.6 billion.  This creates an unchanged year-on-year sales number for the Windows division, and shows that Windows 8 has contributed negligibly to Microsoft’s bottom line.

Selling opportunities in PC Makers

This latest set of earnings figures from Dell present investors with an interesting opportunity for new sell positions. Dell is trading just below its highs for the year (which can be found at $14.50), and with the limited upside seen at current valuations, there is much more of an argument to be bearish on the stock.

Alternatively, sector bears can consider similar positions in Hewlett-Packard Company (NYSE:HPQ), which recently lost its position as the world’s largest PC maker to Lenovo.  Looking at Hewlett-Packard Company (NYSE:HPQ) stock in terms of relative valuations, HP’s higher P/E ratio (at 11.5, versus Dell’s 9.9 P/E value) makes it another option for sector bears.  The most recent earnings release from HP shows that quarterly revenue dropped by 10% (to $27.6 billion) where analysts were looking for a result of $28.12 billion. These downside surprises show that the industry weakness is not isolated at Dell, but rather indicative of a wider set of of difficulties in PC markets as a whole.

The combination of all these negative factors will likely continue to put downside pressure on the PC sector, as weaker profit performance continues to be driven in major changes in consumer behavior.  Forecasts for PC sales continue to show a negative outlook so it makes sense to consider selling these companies while they continue to hold at elevated levels for the year.

The article Does a Huge Earnings Miss at Dell Signal the End of the PC? originally appeared on Fool.com and is written by Richard Cox.

Richard is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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