CSCO - Dell: Potential For Double-Digit Returns

2023-10-19 00:59:44 ET

Summary

• Dell taps into emerging tech trends, boosting its market share in PCs and servers.
• The company showcases growth in PCs, strong market shares, and potential in emerging tech sectors.
• Dell prioritizes shareholder returns through dividends, buybacks, and strategic capital allocation.
• Using DCF analysis, Dell's stock offers an estimated 11% annual return over five years.

Investment Thesis

I believe Dell Technologies ( DELL ) stock is a buy. They've grown in the tech sector, notably in PCs and servers. A DCF analysis suggests an 11% annual return on Dell's stock over the next five years. They're involved in tech areas like cloud services, edge computing, artificial intelligence, and cybersecurity. Dell's focus on shareholders is clear through its dividends and buybacks. With a growing Total Addressable Market and their track record, I see Dell as a solid investment option.

Company Overview

Dell Technologies is a global tech company offering products and services from personal computers to data storage and cloud solutions. The company used a direct-to-consumer model, avoiding traditional retail channels. This approach helped Dell manage inventory costs and set competitive prices. Over time, Dell expanded its offerings to include data center and cloud services for both consumers and businesses. The 2016 acquisition of EMC enhanced its position in the IT infrastructure market. However, Dell faces competition from companies like HP Inc. ( HPQ ), Lenovo Group Limited ( OTCPK:LNVGY ), Apple Inc. ( AAPL ), and Cisco Systems, Inc. ( CSCO ). In my opinion, while these competitors present challenges in areas from PC sales to enterprise solutions, Dell's history suggests they have the capability to adapt and compete effectively.

Dell’s TAM Opportunity

In my opinion, Dell Technologies has a promising outlook based on its total addressable market ((TAM)). Dell's core TAM is already at $775 billion, indicating a solid base for its existing operations. But what catches my attention is Dell's potential to tap into adjacent markets, which offer an additional TAM of $840 billion. These markets include areas like cloud services, edge computing, artificial intelligence, and cybersecurity. Cloud services meet the demand for scalable IT solutions and remote data access. Edge computing, influenced by IoT devices, offers quick data processing essential for real-time tasks. Artificial Intelligence ((AI)) provides automation, data analysis, and tailored experiences, with its role growing with data volume. Cybersecurity is crucial due to rising digital threats, ensuring data and asset protection. Together, these areas highlight current digital necessities and are likely to be central to tech growth in the future. Given Dell's positioning and capabilities in the tech industry, it's anticipated that the company will benefit significantly from these trends over time.

Furthermore, over the last 10 years, Dell's achievements in its core segments are evident. Their overall PC market share increased by 6 points, moving from 11% to 17%. Similarly, their server market share saw a significant gain of 9 points, rising from 21% to 30%. These trends underscore Dell's strength and competitive positioning in these crucial areas.

Dell's Market Dominance and Future Market Share Gains

In my opinion, Dell Technologies is a key player in the tech industry. Their ability to adapt highlights their strength in a changing market. Two main segments drive their success: the Client Solutions Group ((CSG)) and the Infrastructure Solutions Group ((ISG)). The CSG focuses on products like desktops and laptops and has a significant 45.5% market share in PC workstations. On the other side, the ISG targets enterprise needs, offering storage, servers, and networking. Notably, Dell has a 25%+ market share in most ISG products, except the x86 Server. This shows their consistent performance in the business sector. Given their approach to consumer and enterprise segments and their focus on innovation, I think Dell is well-placed to capitalize on future opportunities in tech.

In my opinion, Dell Technologies' growth in the personal computer (PC) market over the past decade is noteworthy as seen in the graph below . Starting from Q1 2011, when they held a unit shipment share of 11.4% worldwide, their consistent expansion to 17.4% by Q2 2023 speaks volumes about their strategic prowess. This year-on-year growth, to me, showcases Dell's resilience and adaptability, especially in such a competitive landscape. Moreover, the rising demand in areas like cloud services, edge computing, artificial intelligence, and cybersecurity suggests a promising horizon for Dell. Their active engagement in these sectors, in my view, reflects a proactive and forward-thinking approach. Considering these dynamics and the prevailing market trends, I believe that Dell is on a path to further success, with a strong potential to enhance its market share in the coming five years.

Dell's Shareholder-Centric Strategy

In my view, Dell Technologies' capital allocation strategy clearly reflects its dedication to shareholders. The management team emphasizes returning capital, highlighting their shareholder-centric mindset. They've committed to allocating 90% of the adjusted free cash flow back to shareholders, split between a dividend program and share buybacks. The dividend program, launched in 2023, returned $1 billion in its first year. I believe this dividend has room to grow, especially with Dell's expectation of a more stable free cash flow from 2024 onwards. Besides, the company has directed $1.3 billion toward share buybacks. The management's inclination to increase buyback intensity, especially when they see the share price as potentially undervalued, further indicates their proactive approach. Given the current valuation which will be elaborated on later in this article, it is likely an effective way of allocating free cash flow which will be positive for EPS growth over the next 5 years. Overall, Dell's strategy seems focused on enhancing shareholder returns.

Financial Analysis

In my assessment, from 2018 to 2023, Dell has demonstrated stable financial results. The company has achieved a Compound Annual Growth Rate ((CAGR)) for revenue of approximately 3.5%, with its revenue escalating from $79,040.00 million in 2018 to $93,616.00 million in the last 12 months. This growth in revenue is complemented by the business reaching profitability in terms of Earnings Per Share ((EPS)), which has advanced from -$3.71 in 2018 to $2.58 in the last 12 months, showcasing the company’s efficiency in converting revenue into profit by improving margins and scale.

In terms of liquidity, the latest quarterly figures indicate cash and cash equivalents amounting to $8,364.00 million . The total debt is recorded at $15,952.00, which seems sustainable given that the business can repay all debt in less than three years’ worth of free cash flow. I believe that Dell’s management has been prudent in managing debt, where over time they have reduced the business' core leverage from 3.2x in 2020 down to 1.8x in 2023, with ambitions of reducing the core leverage down to 1.5x.

In the short term, I expect Dell to recover to their normalised levels of free cash flow of between $5 billion to $6 billion over the next year, as long as no serious macro-economic headwinds are faced. In the longer term, I expect Dell to grow at approximately 5% per year based on a growing TAM and expected market share gains, driven in part by cloud services, edge computing, artificial intelligence, and cybersecurity.

Valuation

I believe that a proper valuation should involve contrasting the market capitalization with the fundamental aspects of the underlying business, including prospective earnings. A discounted cash flow analysis is a methodology I often employ for such evaluations. As of the latest quarter, the present TTM Cash flow per Share for Dell is $7.15. Considering the reason for growth previously discussed, I foresee Dell's Cash flow per Share experiencing a modest annual growth rate of 5% in the coming five years. With this growth projection, the anticipated Cash flow per Share for Dell in 5 years is $9.12.

By applying an exit multiple of 10, derived from what is estimated to be a conservative exit multiple given the expected growth rate and Dell’s historic P/E ratio, the projected stock price target in five years is estimated to be $115.94. Hence, acquiring Dell shares at the existing share price of $67.00 would lead to an anticipated Compound Annual Growth Rate of 11% over the subsequent five years.

Therefore, if you are satisfied with an 11% annual return over the next 5 years, then you may want to consider this stock as a potential buy.

Conclusion

In my opinion, Dell Technologies has navigated well in the tech sector, especially in PCs and servers. Their growth is evident, and they're positioned in key tech areas. I value Dell's focus on shareholders through dividends and buybacks. A DCF analysis suggests a potential 11% annual return on Dell's stock over the next five years. With a growing Total Addressable Market and likely market share gains from areas like cloud services, edge computing, artificial intelligence, and cybersecurity, I believe Dell presents a good opportunity for investors.

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