Dell (NASDAQ: DELL) is, like many of its peers, going through something of an identity crisis. However, Dell has positioned itself for steady growth in the enterprise sector, which is where many PC developers might find their home in a “post-PC” era. I think the post-PC thesis is particularly compelling, and Dell is making slow but consistent headway to weather this eventuality. The company also has been taking shareholder friendly steps recently. In addition to share buybacks Dell joined Apple and will be paying dividends.
Valuation
Dell shares are trading around $12, which nears their 52-week low. In all, the valuation landscape for Dell supports a buy as shares seem undervalued. The lagging P/E for Dell is about 6.8, whereas IBM (NYSE: IBM) and Apple (NASDAQ: AAPL) have P/Es of greater than 12. Obviously, many believe the higher P/E on Apple is justified due to its excellent prospects for growth in consumer electronics and computing. A higher P/E with IBM follows from the extensive number of enterprise-level platforms and applications available from the company, upon which a large stretch of the world commercial sector relies. As Dell’s progress is recognized as consistent, it too will see a higher P/E.
Dell has a price/book ratio of 2.28, which is within the lower and upper quintile values for the information technology sector (1.19 and 3.82, respectively). This suggests a fair valuation. However, Dell’s price/sales ratio of 0.35 is below the sector’s lower quintile value of 0.78, suggesting undervaluation. In all, given the story below, I believe valuation supports a short-term buy recommendation. With a positive economic outlook, a 12-month price target of about $20 is justified.
Where is Dell’s Market?
Dell has consistently held its high-end PC market share through the recent tribulations in the market. However, due to tablet computing and the rise of netbooks, Dell has been ceding much of its lower-budget territory. Vendor notebook sales fell 10% in the first quarter 2012, failing to meet sales execution expectations. Net profit fell 33% to $635 million amidst what management called an “aggressive competitive environment” in the emerging and entry-level computer markets.
To combat much of this, the company needs to execute two major projects. First, the company ought to position itself competitively in the enterprise-level sector. There is some evidence that this is taking place already. Dell-owned IP storage space underwent a 24% increase in sales in the first quarter 2012, and enterprise business solutions available from the company account for about 50% of the company’s total margin. Dell is still maintaining a better profit margin than Hewlett-Packard (NYSE:HPQ)—5.2% over HPQ’s 4.2%. Indeed, these companies compete in many aspects of their business, and Dell’s success thus far on the enterprise front is reassuring.
Second, Dell needs to seriously reconsider its approach in the Ultrabook market—a type of premium portable notebook. Dell is losing this Ultrabook battle at the moment. Lenovo, for instance, is combining Asian-economic cost structure with IBM-engineered mainframes to manufacture their consumer and business laptops; in the first quarter 2012, Lenovo saw a 44% increase in laptop shipments. This comes from the fact that Lenovo, unlike Dell, is willing to maintain profitability on volume sales instead of on single-unit margins. Unfortunately for Dell, over the past year, its average laptop price has fallen about $30 to $705.
Dell’s Consistency and Execution
But this is only half of the picture. Dell has managed to maintain a relatively steady margin over the past few years, despite market fluctuations. Dell’s overall volumes decreased 4% year-over-year for the first quarter 2013 fiscal period, down 10% from the seasonally-strong fourth quarter 2012. With this decrease in volume of sales, however, Dell has maintained an operating margin of 7.0%, which was down only 0.1% from one quarter to the next. The story here is that, though it has had trouble with the favorable increase in margins, nevertheless Dell is able to maintain profitable margins consistently. Of course, this is not major solace as computer prices plunge. But Dell has seen positive results for its new focus on enterprise computing.
Through this, Dell has been able to maintain favorable finances to support its aggressive acquisition schedule. Cash flow increased to $5.5 billion in 2012 from $4 billion in the previous two years, indicating that the company was able to grow cash while engaging in a bout of spending. Though the debt/capital ratio for the company is 49%, Dell maintains an excellent debt rating of A- from S&P. The purchases from the proceeds of this debt are well justified and expansive—largely involving acquisitions. In 2011, Dell resumed its share repurchasing program. This has been its main method of returning value to investors. The company intends to use around 10% to 30% of its free cash flow to repurchase shares over the course of the coming year. After years of paying no dividend since its founding, management has announced that Dell will begin issuing a dividend of $0.32 per year in 2012. This is an excellent decision, and it makes Dell a competitive choice for value-focused investors.
Conclusion
What Dell lacks in dynamism, it makes up for in consistency. Like HPQ, the company is slowly restructuring and, like HPQ, it cannot afford much of a false start or a dead end in strategy. Much of the test for Dell’s resilience on the consumer end will relate to how quickly it can adapt to a “post-PC” market and compete in the Ultrabook wars, which are destined to heat up in the fourth quarter 2012. However, the other side of the coin involves a methodical, macroscopic adjustment and emphasis on the commercial and enterprise front of the business. It is here that Dell has an edge and is executing well. After Michael Dell, the founder of his namesake, resumed the role of CEO in 2007, much of the businesses ultimate success lies in his hands. At present valuation, it is time to buy into this vision. Billionaires David Einhorn, Jim Simons, and James Dinan are among Dell stock holders (see Einhorn’s new picks). Jim Simons and James Dinan initiated positions in Dell during the first quarter at prices that are at least 25% higher than Dell’s current price.
