Technology hardware companies are known to represent rare value plays in a high-multiple technology sector. With industry growth prospects slowing and markets retreating in 2022, many trade at very inexpensive valuations. Dell Technologies (NYSE:DELL) is well-known to most consumers for the quality of its products, and in this analysis, I go over its recent quarterly results release, financial performance and value proposition.
Industry Growth Slowing
Hardware purchases within corporations are expected to slow, as the fear of a recession looms. Moreover, many individuals chose to upgrade their PCs and peripherals during the stay-at-home Covid-19 spread in 2020. Whether to meet the technological needs of remote work or to enjoy gaming and entertainment applications, the majority of consumers seem unlikely to repeat the 2020 technology spending. For the short and even the mid-term, this means stagnation in sales. Chip shortages, increasing materials, labor and transportation expenses also mean elevated input costs and possible margin contraction across the industry.
With a longer horizon in mind, the global personal computers market is expected to grow to $225B, from $162B at the end of 2021 (8.5% CAGR). While this prospect appears rather optimistic, even in the worst-case scenario, some growth should be recorded, with market leaders like Apple (AAPL), HP (HPQ) and Dell being in the best position to capitalize on it.
A hardware company like Dell is widely perceived as a lower-risk, more conservative choice in a market that had, for a while, turned most attention towards high-growth software companies in the early stages of their growth cycles. Even as this narrative collapsed in late 2021 and so far into 2022, Dell hasn’t been performing any better. YTD, the stock is down -28% while the Nasdaq is recording losses of -25% and the S&P 500 -17%.
Deteriorating macro trends, trimmed estimates and lower-than-anticipated results are likely the root causes for the stock’s poor performance so far in the year. Currently, Dell trades at $40 per share ($30B market cap), -35% from 52-week highs.
Q2 Results: Somewhat Disappointing
On August 25, Dell released financial results for the second quarter of 2022. While both EPS and revenue came in line with expectations, the lowered guidance caused a sizable share price drop while raising concerns amongst investors.
Dell reported Q2 earnings of $1.68 per share, within the upper estimated range of $1.55 to $1.70 per share. Revenue for the period was $26.4 billion, up 9% YoY and in line with Wall Street’s forecast of $26 to $27 billion. Operating income increased 25% from a year ago to $1.3 billion. Within the personal computers and hardware product group revenue increased 15% for commercial clients and decreased by -9% for retail consumers. A fact that further highlights weakening consumer spending and sentiment through 2022.
On a higher note, Dell is beginning to see some proceeds in terms of recurring revenue (reaching $1B annually) from its services segment. The higher segment margin should help overall profitability and cash flow productivity, especially as if the company manages to grow recurring revenues further in the mid-term.
Strong currency fluctuations that have led to a stronger US dollar index bring in more bad news. Dell is a company with heavy international exposure, with more than half of its revenues originating outside the U.S. An appreciating dollar means fewer dollars are realized from international sales.
Overall, for the past 10 years, Dell has exhibited a decent growth record, despite failing to follow most of its other technology sector counterparts. Sales have grown at a 10-year 5.9% CAGR, with net income following a similar trajectory at 6.00% annualized growth.
Profitability-wise Dell is showing some signs of struggle. Gross margins have fallen close to 20% over the past couple of years, with net margins standing at 5.0%. Free cash flow margins also stand below optimal levels at less than 7%.
For the next few years, analysts maintain mixed expectations regarding Dell’s financial performance. Revenue is expected to remain stagnant, while earnings per share are forecasted to show mid-single digit growth.
Valuation: The Upside Creator
As things currently stand for Dell, its inexpensive valuation remains, arguably, the biggest potential generator of upside. Especially after the recent stock price drop, the company appears to be attractively valued. Dell is trading at a 6.0x FWD P/E, a 0.3x FWD P/S and 5x EV/EBITDA, all below sector and industry averages. Both P/E and P/S multiples also stand at the lowest levels historically, since the March 2020 pandemic-induced bottoms.
After all things are considered, a few warning signs indicate that despite the stock’s recent drop, more turbulence might lay ahead. Provided, however, that Dell manages to navigate the macroeconomic tailwinds and maintains profitability, the current valuation should offer potential investors enough upside potential. Seeking Alpha