Dell's stock goes up in flames

By Robert Walberg

Like its infamous laptop, Dell's (DELL, news, msgs) quarter just went up in flames.

In what is getting to be a bad habit, the company warned that second quarter sales and earnings would come in below forecast because of pricing pressures and slowing demand for PCs. It sees revenue of $14 billion and earnings per share of between 21 and 23 cents. That’s a far cry from the consensus estimates of $14.23 billion and 32 cents.

Dell shares are getting hammered: the stock, down 13% on a huge spike in volume, is trading at its lowest level in over 5 years.

Given that this is Dell’s fourth consecutive quarter with a revenue warning, it might be time for the PC maker to concede that its strategy of cutting prices in order to hold market share isn’t working. Unless, of course, the goal was to destroy shareholder value and shatter Wall Street’s confidence.

Disaster in the making

Regular readers of this column know that I’ve warned against buying Dell shares for some time out of concern that the company’s pricing plan was a disaster in the making. It was beyond me how anyone figured Dell could increase earnings by aggressively cutting prices while it was spending more to bolster its customer service. The math didn’t work then and it doesn’t work now.

Something has to give or Dell will continue to give its shareholders nightmares. Unfortunately the company became arrogant during its reign atop the PC industry and is paying for that behavior right now. Many of its current and former customers complain of poor customer service and technical support. They bristle over the confusing, borderline misleading, way it advertised very low prices for computers, which get more pricey when even basic components are added.

Small steps back

To its credit, management is trying to resolve these issues. It addition to cutting prices, Dell is simplifying its pricing structure to avoid sticker shock. As outlined back in May, the company plans to invest $100 million to improve customer service. For a company with a cash pile of nearly $8 billion, that might seem like a small amount to spend on a big problem. But at least it’s a start. A slew of new product offerings are also planned for this year’s second half.

While these efforts will help Dell over the long-term, the company is still in a world of hurt. Domestic PC demand is sluggish and the slight improvement we see is driven primarily by lower prices. Dell’s effort to build share internationally is also a double-edged sword because average selling prices overseas tend to be lower. So even if international sales grow faster there will be downside pressure on profit margins.

Toss in the potential for a slowdown in the economy due to rising rates and high energy prices, and Dell faces the very real prospect of slowing corporate, as well as consumer demand, for everything from low-end PCs to high-end laptops and servers. As Casey Kasem might say, the hits just keep on coming.

Hits keep coming

For the next few days those hits will be in the shape of ratings and earnings downgrades from the analysts on Wall Street. Going into today’s session, the Street was expecting Dell’s earnings to rise 19% next year. Those estimates are sure to come down, along with forecasts for the current fiscal year and the next couple of quarters. In fact, the hit parade has already begun, as UBS and J.P. Morgan have already lowered their ratings, earnings estimates and price targets.

Investors considering buying into Dell’s current weakness should be patient. Though the stock is finally approaching valuation levels that accurately reflect the company’s growth prospects, sales and earnings need to stabilize before the stock can start the journey back up. Given that the outlook for both the top- and bottom-line is likely to remain murky for at least another three to six months, the time to go bargain hunting is later this year -- like mid to late-November. Meanwhile stay away from the fire.

Robert Walberg is a financial writer based in Chicago, Ill. He was formerly chief equity analyst at Briefing.com. He is a regular guest on CNN's Moneyline. Mr. Walberg ran for Congress in Illinois in 1994.

At the time of publication, Walberg did not own or control shares of companies mentioned in this column.