November 19, 2010 / 12:13 AM / 7 years ago

Dell's margins blow by Street and shares rise

SAN FRANCISCO (Reuters) - Dell Inc raised its yearly income forecast after third-quarter margins and earnings smashed expectations, helped by sliding costs of PC components and propelling its shares 4.8 percent higher.

The personal computer maker, which vies with Acer Inc for the No. 2 spot in the global PC market, expects stable demand from government and corporate customers and favorable component prices this current quarter.

Analysts pointed to a big beat on Dell’s closely watched gross margin number: 20 percent in the third quarter on a non-GAAP basis versus expectations of 17.5 percent.

“Gross margins jumps out at you from what we’ve seen so far. That’s a level we haven’t seen for a long time from this firm,” said Morningstar analyst Michael Holt.

Analysts said Dell still had to prove to investors its improvement could be sustained. The company did caution that margins would be “tempered” on a mix shift toward the consumer business during the holiday quarter.

“Leverage in the model is going to be key as people gauge the sustainability of what was a very strong gross margin number,” said Stifel Nicolaus analyst Aaron Rakers.

Dell, which benefited from falling prices for components such as hard drives and screens, also credited its discipline on pricing war for shoring up margins.

As corporations continue to upgrade aging hardware, sales in Dell’s large enterprise business rose 27 percent amid good demand for desktop PCs, servers and networking.

“We see stable and good commercial demand for the business, and the component environment, we expect that to continue, and as a result, we think we should have a pretty solid fourth quarter,” CFO Brian Gladden told Reuters in a phone interview.

Gladden also waved off fears that government budget cuts would eat into its business. Dell exposure to weakening government spending was a major question mark following a warning by Cisco Systems last week about weak public-sector spending.

The share price rally following the earnings report reversed a 6 percent loss in Dell’s shares since Cisco’s warning last Wednesday. Dell’s shares were halted after-hours before rising 4.8 percent to $14.32 from their close of $13.67 on Nasdaq.

IN TURNAROUND

Dell’s turnaround effort has proceeded in fits and starts over the past few years, frustrating investors. The company has used M&A to try to diversify its portfolio, but it remains heavily reliant on sales of low margin PCs, which still make up half of its sales.

“I believe the third-quarter results are beginning to demonstrate that the strategy we have described to you over the past year is the correct one,” Chief Executive Michael Dell on a conference call with analysts.

The company’s top line has benefited from the corporate refresh cycle, but Dell has been challenged to translate sales growth into improved profitability.

Dell now expects full-year revenue to track toward the mid-point of the 14 percent to 19 percent growth range set earlier this year. However, revenue in the fiscal third quarter came in below analysts’ average forecast.

It expects non-GAAP operating income should grow between 28 and 32 percent, above an earlier forecast for growth of 18 to 23 percent.

Dell beat earnings forecasts by a wide margin. It reported net earnings for the quarter ended October 29 of $822 million, or 42 cents a share, up from $337 million, or 17 cents a share, in the year-ago period.

Excluding items, Dell earned 45 cents a share, better than the average analyst estimate of 32 cents a share, according to Thomson Reuters I/B/E/S.

But revenue rose 19 percent to $15.4 billion, below Wall Street’s estimate of $15.76 billion.

At it seeks new growth markets, Dell is pushing aggressively into mobile with smartphones and tablets. But that effort has yet to gain traction. The company said on Wednesday that Ron Garriques, the head of its mobile business, is leaving and his group will be integrated into the rest of the company.

The shares of Round Rock, Texas-based Dell gained 2.4 percent in the regular session.

Editing by Edwin Chan, Gary Hill and Andre Grenon

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