Shares of Dell Inc. (DELL) fell 3.5% to $12.56 in after-hours trading and closed at $13.02 on July 13, 2009, when the company announced that it expects a modest decline in gross margin for the second quarter of fiscal 2010 impacted by higher component costs, a competitive pricing environment, an unfavorable product mix due to expensive PC parts and weak demand.
This comes on the heels of declining PC sales as consumers shift from expensive notebook computers towards cheap netbooks and laptops. This shift to low-end PC’s is hurting Dell’s profitability and generating very thin profit margins. Also, Dell has struggled to keep pace with the consumer market due to strong competition, particularly in the low priced desktops and notebook market.
Although the news impacted Dell’s shares, the company did provide some good news. It expects second quarter revenue to increase sequentially as demand for its IT products appears to have stabilized year-over-year. This is consistent with the Street consensus of $12.6 billion and our estimate of $12.8 billion.
Dell did not provide any specific numbers. The company’s CFO said that while demand for its products and services seems to have stabilized, it varied significantly by customer segment and geography as customers are still deferring orders. This does not give a clear indication as to the end of sluggishness in the PC industry.
For the first quarter of 2010, Dell reported revenue of $12.34 billion, a decrease of 23.0% year-over-year, which is below our estimate, primarily driven by softer demand in the commercial market. EPS of $0.24 was also below our estimate as well as below the $0.38 reported in the year-ago quarter. Dell reiterated a cautious outlook.
The company expects to reduce annual costs by more than $4 billion by the end of fiscal 2011. For the long term, it has also set a target of 5% to 7% compounded annual sales growth, operating income at or above 7% of revenue, and cash flow from operations exceeding net income. These forecasts are based on improving IT spending, including a continued double-digit growth rate in demand for computer systems.
Although Dell expects to take down its cost structure, it appears to be headed back in the direction of cutting prices to gain share at the expense of profitability, its traditional reaction to declining market share. Given the company’s history, we do not expect much investor interest in the stock until Dell demonstrates a significant profitable strategy.
Dell lacks the product diversity enjoyed by rivals International Business Machines (IBM), Hewlett Packard (HPQ) and Apple (AAPL), and is in danger of being surpassed by Acer Inc in the global PC market. Dell’s products lack features desired by consumers and the retail distribution of large competitors.
We maintain our SELL rating and believe Dell will continue to struggle posting inconsistent results in future quarters.
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