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PC Stocks-
Finding Long Term Winners Among the Box Makers
Seemingly everyone
in the tech sector these days likes to happily dance around and
repeatedly proclaim to all who will listen that - "the PC
is dead!"
Of course, I
have to step to the plate and disagree. The PC is of course still
very much alive.
While it is
true that handheld devices and mobile phones will increasingly become
important communication, information and commerce devices, the desktop
PC isn't going anywhere. It's definitely here to stay.
Whether the
naysayers like it or not, the desktop computer will remain at the
center of our networked digital universe for many, many years to
come. Try to really use MS Word or Quicken on a cell phone or print
a document from your handheld. It's just not going to happen.
What is true
is that for the most part- in the US particularly- the PC is rapidly
entering a slow growth replacement cycle phase. This helps explain
why worldwide PC shipments fell almost 2 percent in the second quarter,
the first drop since 1986.
Unlike most
investors, this drop in PC shipments doesn't immediately signal
to me that this is a group without a future. While the entire sector
is experiencing PC shipment slowdowns and margin woes, the opportunity
for growth in servers, laptops, storage and services are still very
real.
Regardless of
how this group is trading right now, this is not going to
end up being a sector where everyone loses. With this in mind, I
decided to take a look this week at Gateway, Dell and
Apple Computer- three of the purest plays on the battered
desktop computer sector.
Let's see what
I found out.
Gateway [GTW]
Gateway has
unfortunately become the epitome of "hard times" in the
PC sector. Even the re-appearance of Gateway founder Ted Waitt
as CEO back in February, coupled with a major management shakeup
have yet to get this fallen cow-spotted PC giant back on track.
If anything, Gateway now looks more lost and confused then ever
before, having announced yet another new restructuring plan last
week. The PC maker now intends to turn its 300 retail outlets into
"local technology resource centers" (whatever that means!)
and to restructure its business units.
Gateway reported
second quarter earnings (before restructuring charges) of $9 million
or 2 cents per share, a penny more than Wall St.'s already lowered
expectations. More importantly, GTW warned that profits and sales
would be lower then expected for the remainder of the year. Gateway
has effectively backed off its earlier claim that it would
once again be profitable during the second half of the year. This
is particularly disappointing news since Gateway already fired 3,000
workers and closed 27 stores this year. Sounds like poor cost controls.
As expected,
investors have reacted violently to Gateway's problems over the
past year. At a recent price of $9.67 per share, GTW remains stuck
within a few nickels or so of its 52-week low. With $1 billion in
cash, Gateway retains a strong balance sheet and a well-known brand,
but not much else at this point. Having been unable to develop into
a major enterprise player, Gateway remains hostage to weak US consumer
PC demand. Ted Waitt may be a great fighter, but the reality is
that he re-joined a firm that has failed to evolve with the marketplace.
Ragas Rating:
HOLD
Apple Computer
[AAPL]
With its global
PC market share only in the mid single digits, sometimes it's easy
these days to forget all about Apple Computer [APPL]. That's a big
mistake. Apple relishes being the "think different" dark
horse. Buoyed by an incredibly loyal cult following, Apple may in
fact be the best insulated of the major box makers amidst the current
PC spending wreck. Having only four product lines - two desktops
and two notebooks- have clearly helped keep APPL's operations more
focused and streamlined that its larger, more diverse competitors.
For the most
recent quarter, Apple reported earnings of $61 million or 17 cent
per share,  which
beat consensus estimates by two cents. Sales dropped 19% to $1.48
billion during the period as expected. On a more positive note,
year-over-year education related sales rose 7 percent and Apple
remains on track to open 23 additional new Apple retail stores by
the end of December. Perhaps most importantly, unlike most Wintel
box makers that are being lured into vicious price wars, Apple's
gross margin remains strong at 29 percent.
While investors
have spent the past few weeks worrying about if Apple will meet
the low end of its full year revenue estimates, this is one PC player
still with a bright future. Think long term and focus on the bigger
picture. APPL has an incredibly loyal user base, strong gross margins
for a PC maker and is sitting on a $4 billion cash horde. At a recent
price of $19 per share, Apple is trading for less than one times
next year's projected sales, and for less then half its cash value.
Time to step up to the plate.
Ragas Rating:
BUY
Dell Computer [DELL]
Michael Dell
and Dell Computer are a lot like Rocky Balboa. They love to
dance around the ring, take their punches and get everyone bloody
in the process. Price wars are beautiful for Dell. By relying on
its lean and mean direct sales model, Dell has been able to actually
gain PC market share this year, while all of its major rivals have
been forced to give up ground. Not only does Dell now hold the top
spot in the PC market, but Dell now expects to hold the #1 position
in the US server market this quarter as well.
While Dell has
had to announce layoffs and the consolidation of some facilities
earlier this year, the company remains incredibly solid on the financial
front. Dell reiterated recently that it remains on track to report
profits of 16 cent per share (in-line with analysts' estimates)
for the second quarter. While Dell's overall gross margin of 18%
or so isn't particularly exciting, the firm's diversification away
from pure PC sales is impressive. Dell appears to have a laser focus
on growing the server, networking and services side of its business.
Analysts currently
expect Dell to report mid-teens earnings growth over the next five
years. Even with everyone down on the PC sector long term right
now, I believe that Dell can do this. After all, Dell remains on
the right track to shedding its "PC company" tag all together.
At a recent price of $28 per share, though, DELL shares look pricey.
I want to be a believer, but DELL's forward PE of plus 30 (based
on what I believe to be optimistic earnings estimates!), suggests
that the firm is near fully valued already in my book.
Ragas Rating:
HOLD
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