Dell Inc (Nasdaq:DELL) continues on a path to evolve into an “end-to-end IT provider.” The service side of the equation is already proving successful, but legacy hardware businesses are proving difficult to offset. Dell’s first quarter suggested that the latter category has become an even bigger drag than previously thought. However, the stock has become too cheap to ignore.
First Quarter Recap
Dell is clearly struggling to return to a respectable level of growth and the personal computer division is proving to be a bigger drag than previously anticipated. However, its corporate transformation is on track. Lucrative service revenue added up to around 21% of the total first quarter revenue of $14.4 billion. Product revenue made up the rest and fell 5% to result in a total top-line decline of 4%.
By product category, mobility sales fell the most dramatically, declining 10% to $4.2 billion. Desktop PCs only fell 1%, due in good part to solid sales trends from small and medium businesses. However, large enterprise sales fell 3%, likely contributing to a 7% in software and peripheral sales to $2.4 billion. Consumer-related revenue was the weakest, falling 12% to $3 billion.
The weaker-than-anticipated sales trends meant Dell was caught flat-footed and was only able to lower revenue costs by 2%. Combined with a 1% increase in operating expenses, the negative sales leverage resulted in a dramatic 32% drop in operating income to $824 million. Net income dropped 33% to $635 million, but share buybacks helped temper the earnings decline to 8% as the bottom line fell to 36 cents per diluted share. Higher account payable payments resulted in negative operating and free cash flow for the quarter.
Outlook and Valuation
Estimates are likely to come down as a result of the weak quarter, but for now analysts project a modest 0.4% uptick in full year sales to just over $62 billion. The average profit expectation currently stands at $2.11, with a modest 4.3% rise to $2.20 for all of 2013.
Given the stock price plummet following the weak first quarter, the forward P/E now stands at only six. The trailing free cash flow multiple is even more compelling at below five.
The Bottom Line
Dell’s stock is undeniably cheap and will likely stay this way until the company can consistently grow sales. For now, consumers prefer to buy tablets and smartphones from the likes of Apple (Nasdaq:AAPL) and Google (Nasdaq:GOOG). EMC (NYSE:EMC) also continues to do well selling server and data storage devices. Dell’s best chances are likely to continue to morph into a service-based firm. Accenture (NYSE:ACN) continues to demonstrate just how successful such a focus can be for shareholders.
At the time of writing, Ryan C. Fuhrmann did not own shares in any of the companies mentioned in this article.