AI-Powered Innovation Drives Growth Amid Challenges And Opportunities

Key Takeaways

• Dell's AI focus and investments in AI-optimized servers and engineering enhancements are expected to drive significant future revenue growth and margin expansion.
  
• Potential increases in CSG revenue and EPS are anticipated due to the PC refresh cycle and strategic shareholder return initiatives.
  
• Competitive pricing pressures, exit from VMware, AI growth challenges, and workforce cuts pose risks to Dell's revenue, margins, and long-term competitiveness.

Catalysts

Designs, develops, manufactures, markets, sells, and supports various comprehensive and integrated solutions, products, and services in the Americas, Europe, the Middle East, Asia, and internationally.

• Dell's increasing focus and investments in AI-optimized servers, especially with enterprise and new Sovereign AI opportunities, indicate significant future revenue growth potential as AI adoption increases.
  
• The anticipated PC refresh cycle driven by the Windows 10 end-of-life could lead to a substantial increase in CSG revenue in the near future, despite current muted demand.
  
• Dell's strategic emphasis on expanding engineering capabilities and partnerships in AI, along with a healthy backlog and growing pipeline despite current supply chain constraints, is expected to enhance storage and server revenue and margins.
  
• Continuous optimization of the cost structure, including leveraging AI for productivity improvements, suggests potential for expanded net margins and operating income in the coming quarters.
  
• Dell’s commitment to shareholder returns through buybacks and dividends, coupled with potential growth in operating income, might drive upside in earnings per share (EPS) expectations.

Assumptions

• Analysts are assuming Dell Technologies's revenue will grow by 7.5% annually over the next 3 years.
• Analysts assume that profit margins will increase from 4.3% today to 5.5% in 3 years time.
• Analysts expect earnings to reach $6.3 billion (and earnings per share of $9.08) by about October 2027, up from $4.0 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $7.8 billion in earnings, and the most bearish expecting $4.4 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 20.1x on those 2027 earnings, down from 22.2x today. This future PE is greater than the current PE for the US Tech industry at 20.0x.
• Analysts expect the number of shares outstanding to decline by 0.42% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 7.95%, as per the Simply Wall St company report.

Risks

• Competitive pricing pressures and inflationary input costs are impacting gross margins, as the company expects a decline of approximately 180 basis points, which could affect net margins and operating income.
  
• The exit from the VMware reseller business presents revenue headwinds, reducing total revenue growth potential for the company.
  
• The dependency on specific high-performance AI servers to drive growth in ISG could create risks if there are any supply chain disruptions or delays in component availability, impacting revenue and earnings.
  
• The growing focus on AI in its business strategy may not result in linear progress, as suggested, with the possibility of uneven adoption and deployment cycles in the early stages, potentially affecting both revenue and margins.
  
• Workforce reduction charges and optimizing the cost structure, while aimed at long-term competitiveness, pose risks of short-term operational disruptions and morale issues, potentially affecting productivity and future earnings.

Valuation

• The analysts have a consensus price target of $144.76 for Dell Technologies based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $220.0, and the most bearish reporting a price target of just $106.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $114.2 billion, earnings will come to $6.3 billion, and it would be trading on a PE ratio of 20.1x, assuming you use a discount rate of 8.0%.
• Given the current share price of $125.83, the analyst's price target of $144.76 is 13.1% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.