The Dell Tolls
The Bear Argument
By
Paul Larson (TMF Parlay)
It's always difficult to scribe the bearish side of a Duel after a stock has been hammered on Wall Street. At this writing, Dell is trading at less than half the price it did a mere six months ago. Even though there is not nearly as much optimism built into the stock's price, I would still not buy shares in the company today. Here's why:
Unattractive industry
I'll be frank. I don't like the PC industry one bit. When I look at the industry Dell operates in, I see one with a great deal of competition, rapid technological change, razor-thin margins, quickly depreciating raw materials and inventory, and products with little differentiation that are becoming more and more like commodities.
First, look at the competition. What's the difference between a Dell box and one from Gateway <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GTW)") else Response.Write("(NYSE: GTW)") end if %>, Compaq Computer <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CPQ)") else Response.Write("(NYSE: CPQ)") end if %>, Hewlett-Packard <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HWP)") else Response.Write("(NYSE: HWP)") end if %>, IBM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IBM)") else Response.Write("(NYSE: IBM)") end if %>, or any of the bazillion independent box makers? There are many competitors in the field, and they are all using essentially the exact same components for their products. I do not like investing in companies with commodity products, since sustainable competitive advantages are difficult to come by and retain.
Just to prove how little differentiation there is in the industry, a typical PC from any of the above companies will have an Intel <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTC)") else Response.Write("(Nasdaq: INTC)") end if %> microprocessor, Micron Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MU)") else Response.Write("(NYSE: MU)") end if %> memory, a Seagate Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SEG)") else Response.Write("(NYSE: SEG)") end if %> hard drive, and will run Windows from Microsoft <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSFT)") else Response.Write("(Nasdaq: MSFT)") end if %>. Dell is in basically the same boat as its competitors. Namely, its parts are exactly the same, and it greatly depends on its suppliers to deliver adequate amounts of components at low costs.
Consider that, in the most recent quarter, 78.7% of Dell's revenue went directly toward its cost of goods sold, which is essentially its components. This gives Dell very little pricing power, and puts the company in a position of great dependency on other firms to perform and deliver.
In addition, the rate at which computer components depreciate is astonishing, up to 1% a week. The parts Dell keeps in inventory rapidly lose their value. Moreover, average prices for PCs have been dropping considerably. The average ticket price for a PC dropped 8% in 1999 and is set to drop a similar amount this year.
Hopefully it is easy to see why the PC industry is a tough industry and one I am very hesitant to invest in. The factors above are the main reasons that my associate Zeke Ashton in his Motley Fool Research coverage of Dell only gave the industry a 1.5 attractiveness rating out of 4. I will readily admit that Dell has, by far, done the best job of overcoming these inherent difficulties by becoming the industry's benchmark for efficiency, but the problems of the industry give Dell very little margin for error.
Maturity -- slowing growth
As everyone knows, getting old is no fun. Quite simply, Dell is maturing rapidly, and its growth is decelerating in no small fashion. The days of heady year-over-year revenue and profit growth look like they may be behind the company. Take a look at these numbers and see if you can't make out a trend:
Fiscal Year Sales Growth EPS Growth
1998 58.9% 94.0%
1999 48.0% 65.6%
2000 38.5% 28.3%
2001 (est.) 28.6% 35.2%
2002 (est.) N/A 25.0%
Sources -- Motley Fool Research on Dell, I/B/E/S
Yup, Dell is definitely maturing and seeing its growth slow considerably. Even trading near its annual low, Dell's trailing P/E ratio is near 40 at this writing. Its stock valuation still assumes a moderate amount of growth in the future, and achieving the growth rates longtime Dell holders have become accustomed to will be harder and harder.
Beyond working from a much larger base, Dell is paddling upstream to compete against the tide of falling PC prices. Part of this will be offset by shipping a greater number of units, but the overhead costs will also increase at higher volumes.
Emerging competition
The Internet has been a primary driver of the company's growth over the past half dozen years, but the ways people access and use the Internet are rapidly changing. People are beginning to use everything from wireless devices to inexpensive Internet appliances, none of which are in Dell's area of expertise. In the future, the average user will no longer need a bulky and expensive PC to access the Internet for basic applications such as email or checking stock quotes. Basically, Dell not only faces competition from inside its industry, but also from companies such as Palm <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PALM)") else Response.Write("(Nasdaq: PALM)") end if %> and Nokia <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NOK)") else Response.Write("(NYSE: NOK)") end if %>.
Near-term problems
When the company warned that sales would come in about 3% light of analyst estimates on October 4, it was the third straight quarter that Dell had to water down expectations. Ever since Intel and Apple Computer <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: APPL)") else Response.Write("(Nasdaq: APPL)") end if %> warned about softness in their businesses, especially in Europe, there has been a black cloud over the entire PC industry. Dell has done little to alleviate the market's fears about the industry's health.
The dot-com meltdown is also affecting Dell. As Internet companies find it harder and harder to get financing to buy the basic things they need, the amount of money that they, as a group, spend on computers dwindles. This is no small concern for Dell, since a large number of its customers are businesses.
Either way, even if these problems end up being short-term in nature, the inherent problems of the PC industry are not going to go away anytime soon. Congratulations to those who bought Dell in the early 1990s and profited enormously from the stock's run-up. However, I think the future for Dell will be much less rosy than the past has been.
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