DELL - Broader End Market Improvements Should Help, but Margin Expansion Could Remain a Hurdle

We think much of the near-term good news is in the stock, limiting appreciation potential from current levels. Dell is set to report F4Q10 results on Thursday, February 18. There is upside potential to consensus estimates as the PC market improves and the server refresh continues. We believe shares of Dell have already adjusted for these dynamics, though. To become more constructive on the stock, we need to see margins expand more than 100 bps, reflecting an improved mix, and we do not anticipate this event, yet.

• Modest upside potential to F4Q10, but the stock has adjusted. We expect Dell to meet or beat our above-consensus estimates. Our revenue and non-GAAP EPS estimates are $13.9 billion/$0.29, versus Street consensus of $13.8 billion/$0.27.
Our gross and net margin expectations are 18.4% and 4.0%. The company has
prepared investors for the new reporting disclosures related to amortization of intangibles and other non-operating items; so, there should not be too much noise.

• Dell’s relative PC performance could be mixed. The PC market continues to
improve. Order trends in January were resilient despite entering what is
historically the slower period of the cycle. We expect there to be upside to Dell’s PC performance, particularly in desktop. Our F4Q10 desktop and notebook revenue estimates are $3.1 billion and $4.4 billion, respectively.

• Ongoing server refresh should lend a hand. Dell’s server revenues should
exhibit increasing momentum as the Nehalem-led refresh gains traction. Our
conversations with industry participants suggest Dell is benefiting, but HP and
IBM are as well. So, the relative upside potential may be roughly in line with the
market. Our F4Q10 server revenue estimate for Dell is $1.6 billion.

• Corporate PC refresh would benefit not only Dell. We think the next major
catalyst is a potential corporate PC refresh late this year. Here, we point out that
Dell stands to benefit, but we believe Overweight-rated Hewlett-Packard could be
the bigger beneficiary given its market share gains of the past year and half. HP
holds nearly 300 bps more market share than Dell in enterprise PCs.

• Valuation reset requires margin boost. We believe that end market demand
improvements are factored in the stock. The next leg up depends on a sizable lift in
margins with a mix shift back to the enterprise, which we do not anticipate yet;
and it is this dynamic that keeps us on the sidelines.
Earnings Outlook

We expect Dell to meet or beat our above-consensus estimates for F4Q10. Our
revenue and non-GAAP EPS estimates are $13.9 billion/$0.29, versus Street
consensus of $13.8 billion/$0.27. Our gross and net margin assumptions are 18.4%
and 4.0%. The company has prepared investors for the new reporting disclosures
related to amortization of intangibles and other non-operating items; so, there should
not be too much noise.
For calendar 2010 (fiscal 2011), our revenue and non-GAAP EPS estimates $56.3
billion and $1.21, versus the Street consensus of $56.4 billion and $1.24. Our gross
and net margin assumptions are 18.2% and 4.2%.

Full Report HERE