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Pre-Earnings Jitters Rattle Dell
A downgrade and lowered revenue estimate by a sell-side analyst this morning sends Dell lower with one week to go before its fiscal Q2 earnings come out. However, the slowing sales growth story is far from news. To get a handle on the company's true business growth, investors also need to take Dell's still-strong free cash flow performance into account.
Brian Graney (TMF Panic)
August 2, 2000
The quarterly ritual sacrificing of the share price of Dell Computer (Nasdaq: DELL) at the altar of general growth nervousness hit its high point this morning, and the stock of the Round Rock, Texas-based direct PC marketer was sent barreling downward. The Wise high priest thrusting the dagger into Dell's heart this time was US Bancorp Piper Jaffray analyst Ashok Kumar, who cut his rating on the firm to "buy" from "strong buy" and lowered his revenue estimates for the just-completed fiscal Q2 amid worries of "secular weakness in consumer and commercial [PCs]." Dell Drives Q2 Industry Growth, Fool Plate Special, 8/19/98
PC Commedia Dell'arte, Fool Plate Special, 10/19/99
At its worst, Kumar's downgrade sent Dell's share price to within 10% or so of the stock's 52-week low of $35 per share in early February, adding some more momentum to a recent downward slide. Since hitting a recent high of $53 9/16 on July 17, Dell's stock has slumped roughly 25%.
Here we go again...
The sudden stock drop might seem worrisome to the newer Dell investors out there, but it's far from a surprise for long-time followers of the company. Business visibility oftentimes fades for the boxmakers in the second quarter, which is typically a slower period leading up to the historically stronger second half periods. As a result, Dell's stock usually manages to get hit somehow. In each of the last two years, for instance, Dell's share price has declined by about 10% in the month leading up to its Q2 earnings announcement. This year's Q2 results are set to come out next Thursday.
In both 1998 and 1999, the bugaboo had to do with the profit picture and specifically how declining PC average selling prices (ASPs) would hurt Dell's bottom line. This year, worries about the top-line growth rate have come to the fore. Kumar's sales revision, while getting a lot of play in the press today, is actually at least the fourth instance of such trimming by a sell-sider in the past 10 days. For the record, the consensus (according to Merrill Lynch's week-old data anyway) is for Dell to report revenues of $7.85 billion in Q2. That would equate to 28% year-over-year topline growth, down from the 42% growth posted in the same quarter last year and the 54% growth reported in 1998.
The slowdown lowdown
That Dell's top-line growth is slowing isn't exactly news. For the fiscal year ending this past January, year-over-year sales growth came in at 38% compared to 48% the year before. Likewise, net income growth of 14% last year was down from the previous year's 55% clip. Judging from the income statement alone, it's a no-brainer that Dell's growth is slowing.
However, Dell's story never has started and ended with the income statement alone. Last year's cash flow statement paints a very different picture. Defining Dell's free cash flow as earnings before depreciation minus capital investment and working capital investment (which is how more than one Foolish analyst has defined it in the past), the company's growth appears to be moderating, not declining, as the following chart shows:
Fiscal Year 1998 1999 2000
(in $ millions)
Net Income $944 $1,460 $1,666
YoY Growth -- 55% 14%
FCF $1,189 $1,634 $2,233
YoY Growth -- 37% 37%
FCF/Net Income(%) 126% 112% 134%
Cash is still king
When combing through Dell's earnings statement next week in search of signs that Dell's business is slowing, investors should keep in mind the differences between the company's accounting earnings and its economic earnings. And in Dell's case, there is a big and rather important difference. In the end, it is the cash flows that determine a company's valuation in the marketplace. As long as Dell continues to execute on that front, its valuation will expand. If not, then it will contract. Given such a cash flow focus, it's easier for a long-term investor to see the recent sell-side hand-wringing about Dell for the noise that it is.
What do you think? Are Dell's best days behind it? Post your opinions on the Dell discussion board.
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