Dell Will Shock the Street

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You've seen the headlines:

How is Dell (NAS: DELL) supposed to survive in this kind of environment?

The computing veteran reports fourth-quarter earnings after the closing bell on Tuesday. It's high time to weigh its challenges and opportunities.

Word on the Street
Your average analyst expects Dell to report non-GAAP earnings of $0.52 per share on a cool $16 billion in revenue. That would be a very modest 2% revenue gain and a slight fall from the year-ago period's earnings.

That outlook doesn't seem to mesh with recent results. None of the issues I listed a couple of paragraphs ago are new; even the Thai flooding started to make an impact as early as last October. And yet, Dell's margins keep getting stronger. Trailing operating margins stand at 7.8% today, up from 5% one year earlier. If Dell was able to deliver margin growth like that despite all these challenges and stagnating revenue growth, I don't see how the bottom line could stay static this time.

Yes, hard-drive builders Seagate Technologies (NAS: STX) and Western Digital (NYS: WDC) are passing on some of their disaster recovery costs to Dell. But Dell was able to pull hard drives out of surplus storage to mitigate the direct cost, and is not shy about selling systems at premium prices anymore. In the words of CFO Brian Gladden, Dell's sales teams are now "aligned and incentivized to sustained pricing discipline and maximize operating income and cash flow." Dell is all about protecting its margins now -- it's not the low-margin revenue chaser of the past.

In short, I don't expect a huge hit from the Thai flooding. I do, however, sense a positive bottom-line surprise this week. Shares have gained more than 24% year-to-date, so even a blowout earnings performance might not move the stock very much.

What's the story?
The trick here is not a simple stiff-necked pricing policy -- the company also needs to find the right customers for this approach. That means focusing on the less-price-sensitive enterprise market while consumers can wither on the vine.

That's exactly what Dell is doing. Dell was once famous for its build-to-order business model, in which every machine could be tailored to your specific needs. The downside to that model is that it took a long time to get a Dell system on your desk. Now, the company orders system builds in bulk and delivers server systems in a jiffy. As it turns out, IT directors are happy to pay a premium for standard-issue machines that are available for next-day delivery.

So Dell is more than happy to let Apple (NAS: AAPL) eat its consumer-grade business, one iPhone and iPad at a time. In fact, it would be sort of OK if the same trend moved into the office space, because Dell is more interested in selling big-ticket servers than relatively low-margin workstations.

The high-end ambition does trickle down to simple systems too, though. Michael Tatelman, Dell's chief of North American consumer sales, calls early ultrabooks "flimsy" and notes that Dell's first ultrabook is made from solid aluminum and carbon fiber. "People are going to see value even in the physical nature of it," he says.

This company is tired of scraping maximal sales volume out of a low-margin barrel, and that's the correct strategy for moving on in spite of heavy headwinds. Just ask Apple, you know.

The Foolish takeaway
So in this report, you should see restrained revenue but healthy earnings. Look for more detail on the ultrabook campaign, listen closely when management discusses server sales, and don't be afraid of the incredible shrinking consumer division.

Dell is off to a good start in the new year with that 24% share-price boost. That's impressive, but Foolish analysts have found an even more promising stock for your portfolio. Learn all about The Motley Fool's Top Stock for 2012 in a special report -- free for a limited time.

At the time this article was published Fool contributor Anders Bylund holds no position in any of the companies mentioned. The Motley Fool owns shares of Apple and Western Digital. Motley Fool newsletter services have recommended buying shares of Apple. Motley Fool newsletter services have also recommended creating a bull call spread position in Apple and writing covered calls in Dell. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Check out Anders' holdings and bio, or follow him on Twitter and Google+. We have a disclosure policy.

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