Dell Technologies (NYSE: DELL) is no ordinary tech stock, as evidenced by the fact that the stock is still trading well above pre-pandemic levels. Dell may not be growing at the same pace as its tech counterparts, but the company is making strong GAAP earnings and is buying back its cheap shares. Slow growth is probably the best outcome investors can hope for going forward, but it could be enough to justify a significant multiple expansion, coupled with double-digit returns that could be enough to make better-than-market returns. As the company releases its earnings report on Monday, Nov. 21, the stock’s low valuation makes it a good buy before the press release.
Dell is 30% below its all-time high set earlier this year, but still 80% above pre-pandemic levels.
Much of this strong performance was due to the tremendous progress made in reducing the debt burden. The last time I looked at DELL stock was in July when I recommended it as a buy due to its low price-to-earnings ratio. The stock has since fallen 11%, making the value proposition even more enticing.
In the most recent quarter, Dell’s total revenue grew 9% and non-GAAP operating income rose 4%. However, overall growth does not tell the whole story. The Customer Solutions Group (PC division) posted a solid 9% revenue growth, but on a conference call, Dell noted that the macro environment has deteriorated significantly since the last comment in May, but also noted that they have managed to offset weaker Demand-affecting higher averages selling prices and supply chain improvements in inventory handling. The Company cannot benefit from such offsets.
Dell has gained PC market share in 34 of the last 38 quarters and currently leads the business PC market.
Notably, Infrastructure Solutions Group grew faster due to higher margins in this business segment.
Despite Dell’s CAGR of just 6% since 2019, the company managed to reduce net debt by $37.4 billion, bringing leverage down to 1.7x debt-to-EBITDA.
Management has made the return of cash to shareholders a priority in its capital allocation and is paying quarterly dividends and repurchasing shares. The company repurchased $608 million worth of shares during the quarter and intends to return up to 60% of free cash flow (based on approximately 100% net income converted to free cash flow) back to shareholders.
Looking ahead, Dell expects total revenue to fall 8% year-over-year, reflecting continued weak demand and a likely inability to offset this with price increases. Dell expects earnings per share to be stable year-over-year due to the impact of share repurchases and a larger contribution from the aforementioned higher-margin ISG business unit.
Given a string of disappointing tech earnings reports, it’s no surprise that analysts have lowered earnings-per-share estimates for the most recent quarter, though consensus forecasts still suggest non-GAAP earnings of a recommendation.
Potential shareholders should understand that Dell is not going to deliver the 20% to 30% growth rates that are typical for technology stocks. However, unlike typical technology stocks, Dell earns under GAAP and trades at single-digit earnings multiples.
Management expects earnings-per-share growth of 6% over the long term based on annual revenue growth of 3% to 4%. The shares are trading at 6.3 times earnings, but management’s goal is simply to return up to 60% of earnings to shareholders through dividends and share buybacks. This means that a shareholder return of around 9.5% and a revenue growth forecast of 3% to 4% should be enough to generate double-digit returns. But that’s assuming there aren’t multiple expansions, and I suspect the stock should be revalued over time as the company continues to buy back shares at such an aggressive pace. In addition, by reducing leverage to a target debt/EBITDA ratio of 1.5x, management may have more flexibility to use unallocated cash for other purposes. While management appears to be more focused on using excess cash for M&A, I am hoping for more aggressive share repurchases and for M&A to take place only after the stock has re-valued higher. While management appears to be more focused on using excess cash for M&A, I am hoping for more aggressive share repurchases and for M&A to take place only after the stock has re-valued higher. While management appears to be more focused on using excess M&A cash, I am looking forward to more aggressive share buybacks and M&A that will only take place after the repricing of shares. While management appears to be more focused on using excess cash for M&A, I expect more aggressive buybacks and M&A only after stocks revalue higher. I find it unlikely that a company that buys back about 6% of its shares per year is trading at a profit of 6.3 times its earnings, and this opinion increases significantly if a company buys back as many as 14% of its outstanding shares per year. I could see stocks repricing at 10-12x gains, implying more than 60% upside potential from multiple expansion alone. This multiplier would put it on par with other established technology companies such as Cisco (CSCO) and Oracle (ORCL).
What are the main risks? First, growth is likely to fall outside the 3% to 4% range. Slow-growth companies have long feared that growth will eventually fade and turn negative. Another risk is if management levers the balance sheet to fund M&A ambitions. Another risk is if management levers the balance sheet to fund M&A ambitions. Another risk is that management will use the balance sheet to finance M&A ambitions. Another risk is whether management will use its balance sheet to fund M&A ambitions. I view the path to a multiple re-rating as hinging on lower leverage and a more aggressive share repurchase program, but a debt-fueled M&A initiative would work the opposite direction and possibly cause the stock to keep trading at discounted multiples. I view the path to a multiple re-rating as hinging on lower leverage and a more aggressive share repurchase program, but a debt-fueled M&A initiative would work the opposite direction and possibly cause the stock to keep trading at discounted multiples. I view the path to a multiple rating review as contingent on lower leverage and a more aggressive share buyback program, but a debt-led M&A initiative would work in the opposite direction and possibly force the stock to continue trading at discount multiples. I think the path to multiple rating reviews depends on lower leverage and a more aggressive share buyback program, but a debt-based M&A program would have the opposite effect and likely keep the stock trading at a discounted multiple. It is also worth mentioning that the risk of “taking over” has arisen before. In particular, there is a risk that the share price will fall and the Dell CEO will try to buy shares at a lower price, disappointing shareholders who bought at a higher price.
I still believe that DELL shares should be bought in the face of a technological crash, although the above risks keep them low.
Growth stocks crashed. When you buy it, the streets are full of blood and no one wants to buy it. I provided Best of Breed Growth Stocks subscribers with the Tech Crash 2022 list, and here is my list of where to buy during the tech crash.
Julian Lin is a senior financial analyst. Julian Lin runs Best Of Breed Growth Stocks, a research service that uncovers the high beliefs of future winners.
Disclosure: I/we have a profitable long position in DELL stock through stock ownership, options or other derivatives. This article was written by me and expresses my own opinion. I did not receive any compensation (except for Seeking Alpha). I have no business relationship with any of the companies listed in this article.
Post time: Nov-18-2022