Dell Stock Has Tripled on AI Hopes. Is It a Buy or a Sell?

The
catalyst
for
the
rally
has
been
optimism
about
the
company’s
sales
of
AI
servers,
which
employ
Nvidia’s (NVDA) powerful
graphics
processing
chips.

However,
Morningstar
equity
analyst William
Kerwin thinks
that
despite
this
impressive
growth,
investors
appear
to
be
overestimating
its
potential
benefit
to
the
firm’s
bottom
line:
“in
my
view,
it’s
more
hype
than
it
is
material”
to
Dell’s
profit
outlook.

Key
Morningstar
Metrics
for
Dell
Technologies

Fair
Value
Estimate:
$55.00

Morningstar
Rating:
1
star
Morningstar Economic
Moat
Rating:
None

Fair
Value
Uncertainty:
High

Forward
Dividend
Yield:
1.57%

Dell
Stock
Performance

Source:
Morningstar
Direct,
Morningstar
Indexes,
March
12,
2024

Kerwin
points
out
that
about
60%
of
Dell’s
business
is
PCs
and
monitors,
which
are
a
low-profit,
essentially
commodity
business.
He
says
the
same
goes
for
data
centre
infrastructure,
such
as
servers
and
storage
arrays,
which
are
around
40%
of
the
business.
Within
the
data
centre
segment
are
GPU-enabled
servers
with
Nvidia
chips
built
into
the
systems.
But
Kerwin
thinks
that,
critically
for
Dell’s
outlook,
these
GPU
servers
are
not
the
kind
in
heavy
demand
from
AI
powerhouses
like
OpenAI.
They’re
instead
favoured
by
businesses
looking
to
host
smaller
AI-based
tools
within
their
data
centres.

In
addition,
while
this
business
is
growing
fast,
it
made
up
less
than
2%
of
Dell’s
sales
in
the
most
recent
fiscal
year.
Kerwin
estimates
that
percentage
could
rise
to
10%
over
the
next
five
years,
which
he
calls
“really
fast
growth.”

At
the
same
time,
Kerwin
notes
that
the
GPU
chips
have
a
high
cost
that
Dell
can’t
entirely
pass
on
to
clients,
which
dilutes
the
firm’s
margins.
“It
is
a
growth
driver,
but
by
no
means
to
the
level
that
the
stock
is
trading,”
he
says.

He
says
Dell
has
made
some
shareholder-friendly
moves,
such
as
instituting
a
dividend
and
increasing
share
buybacks.
There
are
also
hopes
that
the
PC
market
will
soon
emerge
from
a
downtrend.
But
all
this
is
“nowhere
near
getting
the
stock
up
200%.”
Kerwin
pegs
Dell’s
fair
value
at
$55,
meaning
the
stock
is
significantly
overvalued.

The
following
are
highlights
of
Kerwin’s
current
outlook
for
Dell
and
its
stock.
The
full
report
and
more
of
his
coverage
of
Dell
are available
here.

Fair
Value
Estimate
for
Dell
Stock

With
its
1-star
rating,
we
believe
Dell’s
stock
is
significantly
overvalued
compared
with
our
long-term
fair
value
estimate
of
$55
per
share,
which
implies
a
fiscal
2025
adjusted
price/earnings
ratio
of
8
times
and
a
fiscal
2025
enterprise
value/sales
of
0.6
times.
The
primary
drivers
of
our
valuation
are
the
firm
growing
its
infrastructure
hardware,
maintaining
firmwide
margins,
and
converting
more
than
100%
of
its
net
income
to
free
cash
flow.

We
forecast
3%
midcycle
sales
growth
for
Dell
and
model
an
uptick
in
fiscal
2025
revenue
after
a
dismal
fiscal
2024,
which
was
affected
by
cratering
demand
and
pricing
for
servers,
storage,
and
PCs.
Beyond
the
downcycle
in
fiscal
2024,
we
model
the
infrastructure
solutions
group
growing
4%
at
midcycle
and
the
client
solutions
group
growing
2%.
We
expect
a
secular
decline
in
consumer
PC
sales
to
hamper
client
solutions,
but
we
believe
Dell
will
more
than
offset
this
with
a
focus
on
the
premium,
enterprise,
and
gaming
sections.
We
see
solid
medium-term
demand
for
on-premises
data
centre
infrastructure
as
enterprises
leverage
hybrid
cloud
and
hyper-converged
infrastructure.
We
also
see
Dell
seeing
growth
upside
from
rising
revenue
from
AI
servers.

Dell
Stock
vs.
Morningstar
Fair
Value
Estimate

Source:
Morningstar
Direct,
March
13,
2024

Read
more
about
Morningstar’s
fair
value
estimate
for
Dell
stock.

Economic
Moat
Rating

We
do
not
assign
Dell
a
moat.
It’s
a
market
share
leader
in
its
core
businesses,
but
we
view
the
markets
in
which
it
plays
as
mostly
commoditized.
PCs,
peripheral
displays,
and
IT
infrastructure
are
price-competitive
markets
that
offer
negligible
switching
costs
and
erode
economic
profits
for
participants.
We
don’t
see
meaningful
operating
leverage
on
larger
volumes
leading
to
a
cost
advantage
for
these
vendors
either,
even
for
a
$100
billion
revenue
gorilla
like
Dell.
These
vendors
can
benefit
in
strong
pricing
environments,
like
during
the
demand
surge
in
2021
and
2022,
but
they
are
ultimately
prone
to
market
cyclicality.

Dell
holds
top-three
market
shares
in
its
core
markets,
but
this
does
not
inherently
demonstrate
economic
profitability.
Dell,
Lenovo,
and
HP (HPQ) control
nearly
60%
of
all
PC
sales,
and
their
respective
market
shares
shift
each
quarter.
The
market
is
consolidating
around
these
top
vendors,
but
it
has
highly
competitive
pricing
and
slim
profit
margins.
Dell
focuses
on
the
highest-growth
sections
–
commercial,
premium,
and
gaming
notebooks
–
but
we
see
the
same
competitive
pricing,
with
other
vendors
whittling
away
excess
profits.
We
also
see
negligible
switching
costs
and
intangible
assets
in
PCs.
Original
equipment
manufacturers
like
Dell
source
critical
components
such
as
processors
and
memory
chips
externally,
and
Windows
is
a
common
operating
system
among
the
top
three
vendors.
We
see
similar
dynamics
in
peripheral
devices
like
display
monitors.

Read
more
about
Dell’s
economic
moat
rating.

Financial
Strength

We
expect
Dell
to
maintain
strong
free
cash
flow
and
prioritise
using
it
to
pay
down
debt
and
return
cash
to
shareholders.
We
forecast
the
firm
to
average
over
$5
billion
in
annual
free
cash
flow
through
fiscal
2028
with
over
100%
free
cash
flow
conversion.

Dell’s
shareholder
return
policy
will
be
a
significant
capital
obligation.
The
firm
launched
a
quarterly
dividend
in
fiscal
2023
and
also
conducts
repurchases.
Management
stated
a
$1
billion
annual
dividend
target
in
its
first
year
and
raised
it
by
12%
for
fiscal
2024.
For
fiscal
2025,
Dell
raised
its
dividend
by
20%,
supporting
our
belief
that
management
is
committed
to
shareholder
returns
and
will
maintain
this
policy
even
if
it
has
to
refinance
debt.
A
more
sour
business
environment
that
affects
cash
flow
and
interest
rates
could
change
this
calculus.

Read
more
about
Dell’s
financial
strength.

Risk
and
Uncertainty

We
assign
Dell
a
High
Uncertainty
Rating.
We
believe
its
greatest
risks
are
long-term
secular
threats
in
its
core
markets,
staunch
competition
for
commoditised
products,
and
its
concentrated
ownership
structure.

Dell’s
core
markets
of
PCs
and
on-premises
data
centre
hardware
have
low
switching
costs,
low
differentiation,
and
staunch
price
competition
with
a
consolidating
list
of
competitors.
While
the
firm
holds
admirable
market
positions
with
its
core
businesses,
maintaining
this
leadership
is
paramount
to
its
performance.
These
markets
are
also
prone
to
cyclical
downturns
that
can
shrink
Dell’s
top
line
and
margins.

We
see
substantial
threats
to
Dell’s
core
offerings,
but
we
don’t
expect
them
to
significantly
harm
its
performance
in
anything
short
of
the
long
term.
Consumer
PCs
face
an
existential
threat
from
tablets
and
smartphones,
though
Dell’s
business
PCs
aren’t
as
threatened.
Public
cloud
expansion
could
also
eat
into
growth
for
on-premises
data
centres
and
subsequently
Dell’s
infrastructure
hardware.
Still,
we
think
hybrid
cloud
arrangements
will
continue
to
make
sense
for
many
enterprises
in
the
long
run.

Read
more
about
Dell’s
risks
and
uncertainty

DELL
Bulls
Say

Dell
is
an
enterprise
IT
hardware
behemoth,
with
top
market
shares
across
personal
computers,
peripheral
displays,
x86
servers,
and
external
storage
arrays.

We
expect
Dell
to
continue
generating
considerable
free
cash
flow,
and
applaud
the
company’s
prioritisation
of
sending
it
back
to
shareholders
via
its
dividends
and
buybacks.

Dell’s
debt
is
now
investment-grade,
and
its
balance
sheet
is
better
positioned
to
give
it
operational
flexibility.

DELL
Bears
Say

Dell’s
core
businesses
compete
in
commoditized
and
cyclical
markets
that
erode
economic
profits.

CEO
Michael
Dell
holds
a
controlling
position
in
the
company,
and
his
interests
could
deviate
from
those
of
minority
shareholders.

Dell’s
need
to
refinance
some
debt
could
limit
its
organic
investment
or
shareholder
returns,
and
it
may
face
an
unfavourable
rate
environment
in
which
to
do
so.

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