Inside Wall Street: The PC Refresh Cycle Could Reinvigorate Dell's Stock Price

The much-anticipated replacement cycle for aging personal computers that kicked in during the second quarter is buoying expectations that sales and earnings growth at Dell (DELL) will regain badly needed vigor. Dell is one of the world's largest manufacturers of PCs, which accounted for 56% of total sales last year. Some investors believe Dell will beat its own forecast of a 14% to 19% revenue growth and an operating income advance of 18% to 23% in fiscal 2011 ending Jan. 31.

These pros are betting that Dell will be one of the big winners as the tech group snaps back this year and next. One more bullish sign is Intel's (INTC) robust results for the second quarter and its mention that corporate demand for new systems was strong.

After pulling strongly ahead of the market in late 2009 and early this year, tech stocks have lost much of their wind. But some value investors find Dell and select major tech stocks a bargain again.

"Industry fundamentals are getting better and, net-net, earnings in the group are recovering nicely," says David A. Katz, chief investment officer at Matrix Asset Advisors, whose portfolio of $1.1 billion in assets is laden with some big tech names. Since he's looking for a stronger-than-expected economic recovery, Katz says the techs should be among the stocks to accumulate.

After Surging, the Stock Has Fizzled

His top choice is Dell, which ranked No. 2 in global unit shipments in fiscal 2010, with about 13.1% of the world market. In the U.S. alone, Dell is also second-largest in unit shipments, with a market share of 24.5%. Dell sells servers and storage products, as well as information-technology services to its customers.

The pent-up demand for PCs, including the invigorated demand from large enterprises that are starting to replace their old hardware and computer systems, will definitely bolster Dell's sales and earnings growth, says Katz -- and thereby enhance the value of its shares.

Like most other techs, Dell shares surged in 2009 and more than doubled to $17.50 in early 2010. However, the stock has since fizzled -- and tumbled to $12 as investors started worrying about the global recovery's sustainability. But at its currently depressed price, says Katz, Dell represents good value because he pegs its worth is closer to $20 a share, based on projected higher sales and earnings, mounting free cash flow and renewed growth in PC demand worldwide.

At a recent meeting with analysts, Dell said it sees overall demand stabilizing based on feedback from its customers. PC market growth, Dell figures, should be around 20% over the near term. Dell reports second-quarter earnings on Aug. 19, and the consensus is for earnings of 30 cents a share.

Dell's "Attractive" Cash

Katz says the so-called refresh cycle will definitely reignite interest in Dell's stock. "The upgrades by commercial and enterprise customers will continue for sometime," says the portfolio manager, because plenty of its customers held off buying new equipment during the recession. So, Dell is surely seeing renewed demand as America businesses can no longer wait to update their technological prowess to compete with rivals.

Particularly alluring for Dell investors are its balance sheet and strong cash position. "We continue to view Dell's cash profits as an extremely attractive aspect of the story," says Ananda Baruah, tech analyst at investment firm Brean Murray Carret, who rates the stock a buy with a price target of $18 a share.

She figures Dell can generate $4 billion in free cash flow this year, suggesting free cash flow of $2 a share -- higher than her earnings estimate for fiscal 2011 (ending Jan. 31) of $1.28 a share and $1.45 in fiscal 2012. In fiscal 2010, Dell earned $1.05. Baruah figures Dell has a net cash stash of $6 a share.

In terms of revenues, she expects sales in fiscal 2011 to leap to $61.6 billion and further expand to $65.66 billion in fiscal 2012 vs. fiscal 2010's $52.9 billion.

A Highly Compressed P-E

Also attractive is Dell's valuation relative to other tech peers. Its price-earnings ratio of 9.7 times fiscal 2011 earnings forecasts is about in line with that of Hewlett-Packard (HPQ) but is at a big discount to giant IBM's (IBM) 11 times.

In 2006 when Dell's stock traded at more than $32 a share, its average p-e multiple was 22.3. Earnings that year were $1.14 a share on sales of $57.42 billion. Judging from those figures, they show how compressed Dell's p-e ratio has become -- and how undervalued its stock is – based on projected fiscal 2011 sales and earnings that are higher than the sales and earnings five years ago.