IT bellwethers Cisco Systems (Nasdaq:CSCO) and Intel (Nasdaq:INTC) set the stage last week for more ugly earnings announcements, but Dell (Nasdaq:DELL) lightened the mood with surprisingly good third quarter numbers. Investors shouldn't get too excited, though. The computer giant's shrinking revenues suggest that problems have been delayed, but not avoided.
Short-Term Patches
The dramatic slowdown in IT spending resulted in nearly 60% being knocked from Dell's share value since September. The company's net income of 37 cents per share for the quarter topped analyst expectations of 33 cents per share and soothed some market worries. However, Dell's quarterly revenues dropped to $15.162 billion, down 3% from the same period last year. Furthermore, revenues plunged nearly 8% from the previous quarter.
In the short-term, Dell may be successful in propping up margins through yet another round of cost-cutting measures. Third quarter operating income improved 22% to $1 billion, or 6.7% of revenue, driven by gross margins of 18.8%. But Dell's history strongly suggests that earnings eventually will give way to falling revenues. (Learn more about operating income at Zooming in on Operating Income.)
Long-Term Problems
Dell's recent shift from a single-tier, direct-to-customer sales model to a two-tier model that relies on channel partners will not bring the company overnight benefits. Hewlett-Packard (NYSE:HPQ), now the world's largest PC maker, took nearly 10 years to develop its retail channels. Moreover, Dell's cost-cutting efforts and new go-to-market strategy may be admirable, but ultimately they are unlikely to produce sustainable revenues and earnings growth over the next year.
Unlike its peers Hewlett-Packard and IBM (NYSE:IBM), which are buffered by a high proportion of revenues from recurring services and solutions, Dell is heavily exposed to a much less reliable PC and server hardware sales market. Except for its small service and printer cartridge businesses, Dell has drastically lower exposure to recurring revenues than its competitors.
Apple In The Garden
To grow its computer business year-over-year, Dell must sell the same number of PCs as last year, which is no small feat even in a good year. Heading into a severe recession with demand declining, prices plummeting and consumer appetite for Apple (Nasdaq:AAPL) increasing, it could be impossible.
Currently trading near $9.50, or seven times forward earnings, Dell looks cheap. In addition, the company is sitting on a whopping $7.9 billion, or $4.05 per share, in net cash on its balance sheet. But these few attractive features come up ugly in the bigger picture.
Bottom Line
In normal circumstances, analysts would predict that Dell's stock has bottomed out. But in the frighteningly shaky market of late, Dell is too risky. All stocks are falling fast these days. Those, like Dell, with revenues and earnings heading downward fast, tend to fall much further than you might expect
