Qualiport

[ July 12, 2000 ]

Dell Revisited

By Maynard Paton (TMFMayn)

Carburton Street, London -- After promising a few weeks ago to review the Qualiport companies that have hidden in the wings in terms of Qualiport coverage, I'm finally going to turn my attention to Dell Computer Corporation (Nasdaq: DELL). Out of all the constituents within the Qualiport, Dell has had by far the lowest Qualiport profile. Having had a quick skim of the archives, I think the last time we reported on Dell appears to have been just after our purchase in January of last year, when we appraised their 1999 full-year results.

In that time, Dell's shares have risen from around $45 to $50. Needless to say, that achievement puts them towards the sharp end of the Qualiport's performance league table. Having said that, Dell's shares have hardly been part of the tech stock surge that the Nasdaq market as a whole enjoyed over that time.

All in all, I think it's high time we revisited Dell and, in particular, their results for the twelve months to 28th January 2000.

Dell's business

Briefly, here's how the $130b company describes itself and its operational advantages in its most recent financial statement.

"Dell is the world's largest direct computer systems company. The company was founded in 1984 by Michael Dell on a simple concept: By selling computer systems directly to customers, the company could most efficiently understand and satisfy the computing needs of customers."

"The company believes that the direct model provides it with several distinct competitive advantages. The direct model eliminates the need to support an extensive network of wholesale and retail dealers, thereby avoiding dealer mark-ups; avoids higher inventory costs associated with the wholesale/retail channel and the competition for retail shelf space; and reduces the high risk of obsolescence associated with products in a rapidly changing technological market."

Further details and background information on the company's operation and history can be found here on the rather impressive Dell corporate website.

Dell Financials

For now, I'll just concentrate on the two main financial attractions of Dell -- the sales growth record and cash generation. On Friday, I'll try to dig a little deeper in to Dell, covering, amongst over things, hefty employee compensation through stock options.

It goes without saying that the growth in the demand for PCs and all things Internet has been a considerable help to Dell. Here's the company's astounding five-year record.

Year ended Jan    2000     1999     1998     1997     1996
                 ($m)     ($m)     ($m)     ($m)     ($m)

Turnover         25,265   18,243   12,327   7,759     5,296
Gross profit      5,218    4,106    2,722   1,666     1,067
Operating profit  2,263    2,046    1,316     714       377
Net income        1,666    1,460      944     518       272

Basic EPS*         0.66     0.58     0.36    0.19      0.09

*Earnings Per Share

A fabulous performance. Sales have increased at an average compound rate of 47% since 1996 with profits after tax, aided by improvements in the operating margin, witnessing a staggering average annual leap of 57%. Even more impressive is that all the historic growth has come without recourse to acquisitions. These days, nearly 50% of the company's turnover comes from online purchases, with the dell.com site now averaging $40m of revenues a day. So, no problems with that old Qualiport chestnut of pedestrian sales growth at Dell then.

Small doubts start to creep in when delving into the drivers of that sales growth -- the revenues generated from each computer sold.

Year ended Jan    2000    1999   1998    1997    1996
                  ($)     ($)    ($)     ($)     ($)

Revenue per unit  2,250   2,350  2,600   2,700   2,850

The price of the average computer ordered through Dell has declined between 5-6% over the past five years. On the face of it, it looks like Dell are having to acquire ever more customer orders each year just to maintain the historic sales performance, a situation that can't last forever.

Unit price deflation

The breakdown in product revenues shows how Dell have been running uphill to maintain the sales performance in their traditional PC market place. It also highlights the broadening of Dell's product range into higher-spec offerings, such as corporate servers and workstations, to offset the tumbling desktop prices.

Product revenues

              2000   Increase   1999   Increase   1998
              ($m)     (%)      ($m)     (%)      ($m)

Desktops     13,568   23.6     10,979    36.9    8,022
Notebooks     5,847   51.5      3,859    74.6    2,210
Enterprise
 systems      3,828   74.6      2,193    99.2    1,028


Product Unit Growth

              2000   Increase   1999   Increase   1998
              ($m)     (%)      ($m)     (%)      ($m)

Desktops               46.0               55.0         
Notebooks              61.0              108.0         
Enterprise systems     81.0              130.0         


Resulting Unit price change

Desktops              (15.3)             (11.7)        
Notebooks              (8.7)             (16.1)        
Enterprise systems     (3.5)             (13.3)        

Look at how a 46% increase in the sale of desktop computers in the year ended January 2000 resulted in just a 23.6% rise in that product's revenues. Those two figures equate to a 15% year-on-year revenue decrease for the average PC unit sold. A similar picture is told within the two other product categories for fiscal 2000, but thankfully to a lesser extent.

Aggressive market penetration

A hint of the pricing pressure Dell looks to be suffering was given in the "management's discussion" of the 2000 numbers: "Notebook computer unit sales increased 61%, primarily as the result of pricing actions... Desktop computer systems unit sales increased 46% during fiscal 2000. This increase was primarily attributable to the Company's aggressive market penetration of new and high-end products."

Double-digit unit price deflation isn't particularly associated with any corporate "franchise". But these revenue-per-unit figures are perhaps influenced by the discounts received by Dell's increasing high-volume customer base. Looking at the operating margin performance over the last five years should reassure shareholders over threats of a suicidal profit course.

Gross margins currently remain higher than those recorded in 1996 (20.7% versus 20.1%) and operating margins have widened in that period (9.8% versus 7.1%) too. So, the steady margins indicate that the customer pricing demands can be passed onto Dell's suppliers, or alternatively, any economies of scale can be passed onto the consumer to gain market share. Either way, Dell has appeared to be more than capable with coping with the fast-declining average unit sale in the past.

Working Capital

This is an area where Dell excels. The company is a veritable cash machine.

Year ended Jan    2000     1999     1998     1997    1996
                  ($m)     ($m)     ($m)     ($m)    ($m)

Operating Profit 2,263    2,046    1,316      714     377

Change in 
 Debtors          (394)    (598)    (638)    (200)   (196)
 Stock            (123)     (41)      16      177    (138)
 Creditors         988      743      638      581      59
 Accrued and other
  liabilities      416      255      644      141     126
 Other             (75)       8     (295)     (40)    (46)
Total change       812      367      365      659    (195)

End of year cash
 balance         6,853    3,181    1,844     1,352    646

Corporate customers paying promptly, a very tight manufacturing and stock control process and extending terms with suppliers have all helped Dell significantly advance its cash flow generation. Having an end-of-year cash balance that has expanded 10-fold in five years speaks for itself. The improvement in working capital can be seen with the "average working capital day" calculations below.

Year ended Jan   2000     1999     1998    1997    1996

Debtor Days        34       36       36      37      42
Stock Days          6        6        7      13      31
Creditor Days      58       54       51      54      33

Cash conversion
 cycle            (18)     (12)      (8)     (4)     40

In fiscal 2000, components bought by Dell were paid for 58 days later. Six days after receiving the chips, the components are in a customer's computer. With the customer paying, on average, 34 days after purchase, it leaves 18 days for Dell to accumulate additional interest on the supplier-owed money. Great stuff.

A spot of Rule Shakery

That covers the financial basics of Dell -- phenomenal sales growth, falling unit prices, steady margins and a full-on cash volcano. The niggle over unit prices aside, the growth figures for a company of Dell's size are superb. On Friday, I'll review other aspects of the Dell financials and summarise my thoughts.

But something I'm unlikely ever to do is go into "Rule Shaker mode" and to forecast the future of the PC. So, a question for you to ponder until Friday. Will today's PC industry suffer from tomorrow's handheld devices, digital televisions and simple Internet-only computer models? If you know what the future has in store for the current type of desktop, then please enlighten me with your thoughts on the Qualiport discussion board, in the Resources section below.

Where Next?

Review these previous Qualiport features on Dell:

Fool Buys Dell
An early stab at Dell's valuation
Accounting for Dell
Dell Diving
Dell discussion board (US Fool) | website