Ticonderoga: 'Exit this highway to Dell' before it's too late

Dell delivered second-quarter earnings on Wednesday that beat the Street’s estimates, reporting net profits of $890 million, or $0.05 per share above analysts’ consensus. The world’s No.2 PC vendor missed revenue estimates however, and it slashed guidance for the remainder of 2011. In a note to investors on Friday, Ticonderoga Securities analyst Brian White told clients to head for the hills and “exit this highway to Dell” before trends get worse. “Despite the transformation of Dell’s portfolio that we believe will ultimately have a long-term positive impact on the company, we cannot overlook Dell’s high exposure to the public and consumer markets in a period of growing austerity programs and weakening consumer demand,” White wrote. “At the same time, we have concerns regarding Dell’s surging operating expenses as the company invests in new businesses that we believe will result in incrementally higher operating leverage in a tough environment and could cut more deeply into profits versus the last downturn.” White dropped his rating on Dell stock to Sell, setting a new 12-month price target of $9.25. More thoughts from White follow below.

“Putting aside our concerns surrounding weakening demand in key Dell verticals, we really do like what Dell is doing to its portfolio and we believe this will pay off for the company over the next 3-5 years,” White continued. “Although traditionally thought of as simply a leading PC vendor with a strong server franchise, Dell has been aggressively expanding its portfolio in areas such as services, security, storage, software and networking in an effort to provide customers with higher value add enterprise solutions. Specifically, the Perot deal pushed Dell into IT services in a bigger way, while the recent Compellent deal positions the company well for next generation SAN storage solutions and the pending Force10 Networks acquisition is Dell’s first big push into the data center networking market with internally developed solutions.”

The analyst went on to identify several risks the PC vendor currently faces. While White sees Dell’s current valuation on the lower end, he believes coming earnings over the next few quarters may still “surprise on the downside,” with particular considerations given to the weakening economy and government spending cuts. “Given the public spending weakness this time around and higher operating expenses, we believe earnings could have further downside potential,” the analyst said. He continued, “We generally think of IT sales growth at 4-6% per year, however, Dell has not kept up the market over the past five years and the company is only forecasting 1-5% growth for FY12.”

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