As Corporate PC Demand Rises, Dell's Up, HP's Down
Over the last two decades, the lead in source of technology spending has changed hands a few times. During the 1990s, there was a boom in corporate technology spending as companies upgraded their computing infrastructures to compete in e-business.
Companies bought PCs online largely from Dell. As I wrote last June, Dell set up its business in a way that enabled it to set its costs 14% below those of competitors like Compaq (that HP bought in 2002) while charging companies a 13% higher price because of the convenience its online purchasing process gave companies who could order PCs configured for their specific requirements.
During the 2000s, companies lost interest in IT as a source of competitive differentiation and focused on trying to make it more efficient by shifting basic functions to lower cost countries. PC growth came from consumers -- who like to buy PCs after checking them out in retail stores -- where HP excelled and Dell did not. Dell's strength selling to companies became a weakness when it came to consumers -- and Dell's market capitalization fell $68 billion as a result.
Last year, Apple introduced the iPad and to my surprise, it has become a huge hit -- at least a decade after Microsoft (NASDAQ: MSFT) then-CEO, Bill Gates, walked around talking about the benefits of tablet computing. In the current decade, we are seeing the iPad cut into sales of PCs for consumers and that's hurting HP the most. Overall that PC market is shrinking at a 3.2% globally and 10.7% in the U.S.
Meanwhile, after a year of record corporate profits of $1.68 trillion and nearly $2 trillion in balance sheet cash, companies are finally beginning to spend more on technology after holding off for much of the previous decade. For example, in the first quarter of 2011, U.S. GDP growth was a slim 1.8% but that weak performance masked a much higher 11.6% spike in corporate technology spending -- a boom to Dell.
These trends help explain why HP's first quarter results were disappointing and why Dell delivered. At HP, consumer PC sales tumbled 23% in the first quarter and HP reduced its sales forecast by $1 billion. Meanwhile Dell beat analysts’ estimates because of corporate demand -- where it has traditionally done well -- while its sales to consumers fell 7.5%. Meanwhile tablet sales, the iPad and others, are expected to climb at a 52% compound annual rate from 70 million in 2011 to 246 million in 2014.
Does this mean you should dump HP shares and buy Dell? To think about that, To help with that decision, we can look at its price-to-earnings-to-growth (PEG) ratio — a way to determine whether the value that the market assigns a stock is justified by the rate at which it expects the company’s earnings to grow. I think a PEG of 1.0 is a fair price, and anything below that is a bargain.
Based on PEG alone, I'd buy HP and sell Dell. How so? HP's PEG of 1.06 looks reasonable -- its P/E is 9 on earnings expected to grow 8.5% to $5.69 in 2012. Meanwhile Dell's PEG of 2.45 looks over-priced -- its P/E is 11.8 on earnings expected to grow 4.8% to $1.76 in 2012.
I may be going out on a limb here but based on Dell's 83% earnings growth in the first quarter to 55 cents a share (beating estimates by 10 cents), I think the 4.8% 2012 growth forecast could be way too low. And with HP earnings up a mere 5% in the quarter, the 8.5% 2012 forecast might be too high.
Tablet growth is going to be strong in the years ahead but it remains to be seen how strong it will be in the corporate market. Nevertheless, it would not hurt if Dell could offer a compelling corporate tablet -- its Streak currently controls a tiny 3% of the market -- in a decade during which companies are likely to boost their IT spending dramatically, Dell's stock should benefit.