Analysts call Dell's 3Q squeeze a temporary glitch

Dell Computer Corp. (Nasdaq: DELL) will report its third-quarter earnings Thursday with First Call consensus predicting a profit of 18 cents a share. That figure was revised downward after company officials warned that rising memory prices would erode profit margins in the quarter.

While analysts were quick to lower their consensus estimate from 20 cents a share to 18 cents, most are convinced the squeeze on gross profit margins will be temporary and that strong PC demand will help push the stock higher through 2000.

Dell officials said a supply shortage for some memory components and liquid-crystal displays used in notebook computers meant memory prices jumped as much as 25 percent in the quarter.

"We are managing the memory situation carefully and are working to offset the cost increases with efficiencies in other parts of our business," said CEO Thomas Meredith in mid-October. "We are also taking actions to reduce overall memory consumption, including advertising system configurations with lower amounts of base memory."

Dell still the one to beat

Despite the profit warning, Dell shares only fell about $6 a share and were trading around $41 a share Wednesday afternoon.

"Dell's still the company to beat in this space," said Jonathan Ross, an analyst at ABN AMRO. "They have a great business model. This is likely a one-time event that will have no affect on valuation going forward."

Ross said he's expecting a third-quarter profit of 18 cents a share on sales of $6.6 billion, roughly a 37 percent improvement from the year-ago quarter.

Last quarter, Dell beat Street estimates by 2 cents a share, earning $507 million, or 19 cents a share, on sales of $6.14 billion.

One time glitch

Analysts were also encouraged by management's claims that the Y2K dilemma wouldn't hamper its sales through the rest of the fiscal year.

Ashok Kumar, an analyst at Piper Jaffray, said Dell should be able to sustain a 30 percent to 35 percent revenue growth and that all indicators point toward strong demand through fiscal 2000.

"As expected, the spike in DRAM pricing and the inability to pass the costs on to the company's transactional customers will have a negative impact on gross margins in the quarter," Kumar said in a research note. "The current quarter is impacted by a shortened reaction time. We do not believe Dell will be impacted next quarter, as the company has more time to adjust to this transitory supply/demand imbalance."

Back in August, CFO Tom Meredith told analysts the company's efforts to capitalize on the small business and home user market would minimize any decline from large corporate clients.

"Our outlook for the rest of this year and all of next remains very healthy as Y2K concerns appear to be diminishing," Meredith said. "We see no reason for our historical pattern to deviate."

Growth ahead?

Most analysts are expecting worldwide PC sales growth of between 12 percent to 15 percent in 2000. The emergence of faster multimedia chips from the likes of Intel Corp. (Nasdaq: INTC) and Advanced Micro Devices Inc. (NYSE: AMD) is expected to create more demand for top-end machines with higher profit margins.

"As long as this short-term memory situation doesn't have any significant impact on Dell's business structure, the stock will keep growing at the level investors have come to expect," Ross said.

Dell shares fell to a 52-week low of 29 _ last November before rallying to a high of 55 in February.

After Dell's profit warning, analysts revised their fiscal 2000 estimates downward from 76 cents a share to 73 cents a share.

Twenty-four of the 34 analysts tracking the stock maintain either a "buy" or "strong buy" recommendation.