What can one say about Dell (DELL)? The company’s public profile does not exactly inspire excitement nowadays, selling personal computers and peripherals on the retail and enterprise levels. One could be forgiven for being unaware that the firm also sells networking and enterprise storage equipment, IT services, and other consumer products. Although the markets that Dell occupies are large and lucrative, they seem to have the air of ordinary nuts-and-bolts about them; nothing that really fires the imagination for the most part.
Perhaps this is the reason that Dell’s share price is so low; the firm offers a free cash flow yield based on the latest year’s earnings of 10.2%, a yield that would normally be associated with a company going through incurable stagnation, which Dell is not. And when one considers that the company also has roughly $12.5 billion in excess cash (equal to nearly half of its market cap), the free cash flow yield improves to 18.5%, which presents a very attractive prospect indeed.
Although Dell is often viewed as mainly a retail seller of computers to consumers, its consumer division was responsible for only 20% of sales for fiscal year 2011 (Dell's fiscal year ends at the end of January). 24% of sales came from small and medium businesses, 27% came from public customers, and 29% came from large enterprises. Furthermore, personal computers accounted for only 55% of their revenues, with software and peripherals constituting 17%, services constituting 12%, and enterprise solutions such as servers and networking equipment and storage constituting 16%. Dell's services and server and networking equipment were their fastest growing divisions for year 2011 as compared to 2010, indicating the company's intention to expand to a broader and hopefully more lucrative market.
Although Dell is priced as though sales will stagnate or even decline, analysts are estimating that both sales and earnings will increase for 2012 and 2013, with consensus estimates of sales growth of 5.5% for 2012 and 4.1% for 2013. I normally greet analyst estimates with skepticism, but I find the assumption of this level of modest growth credible given Dell’s decision to expand their product lines in services and enterprise product. At any rate, I find it more credible than the assumption of stagnant income and earnings that would explain Dell’s current price.
Turning to the figures, I spoke earlier of the size of Dell’s excess cash position. The company holds $13.913 billion in cash, $452 million in short term investments, and $704 million in long term investments, total $15.069 billion. (All figures come from Dell's recently released 10-K filing with the SEC).This is more than half of its market cap of $28 billion. Of course, some of the cash and investments are needed for Dell’s day-to-day operations and liquidity needs, so not all of them can be considered excess.
A commonly-used estimate for the excess cash of a company is the total cash on the books minus the extent to which its current liabilities exceed noncash current assets. Dell’s current liabilities total $19.4 billion, but the figure is complicated in that $3.2 billion of current liabilities consists of “short-term deferred services revenue.” This amount represents payments for warranties that Dell has issued over the last few years that have not expired.
In other words, Dell already has the money, but it cannot treat that cash as revenue except as the contracts amortize. However, as with all insurance situations, Dell does not expect to pay out all of its warranty income as future claims. In fact, Dell estimates in its annual report that its total warranty liability is only $895 million, and so that figure, rather than the total deferred revenues, should be counted as a current liability when computing excess cash.
So, total current liabilities consist of $851 million in short-term debt, $11.293 billion in accounts payable, $4.181 billion in “accrued and other,” and $895 million in warranty liability, total $17.220 million. Dell’s current noncash assets include $6.493 billion in receivables, $3.643 in financing receivables from its financial services, they extend others, $1.301 billion in inventories, and $3.129 in other current assets, total $14.656 billion. The difference is $2.564 billion, which, subtracted from $15.069 billion, leaves $12.505 billion, or 44.7% of Dell’s current market cap of $28 billion, in excess cash.
On top of this ample supply of excess cash, Dell also produces impressive free cash flow. In fact, with a free cash flow yield of 11.1%, the free cash flow alone would justify an investment in Dell. When the $12.5 billion in excess cash is removed from the market cap, the free cash flow yield on the remaining $15.5 billion, minus the income produced by the excess cash and investments themselves, comes to an amazing 18.5%. Such a yield is almost unheard of for a company with long-term viability.
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Dell’s free cash flow, fiscal years 2008-2011 (millions):
FY 2011 | FY 2010 | FY 2009 | FY 2008 | |
Sales | 61494 | 52902 | 61101 | 61113 |
Operating income | 3433 | 2172 | 3190 | 3440 |
Depreciation | 970 | 852 | 769 | 607 |
Capital expenditures | (444) | (367) | (440) | (831) |
Investment income | (53) | (59) | (170) | (510) |
Interest expense | (199) | (160) | (93) | (45) |
Pretax free cash flow | 3644 | 2439 | 3256 | 2661 |
Tax rate | 21.3% | 29.2% | 25.5% | 23.0% |
Free cash flow | 2868 | 1727 | 2426 | 2049 |
I should point out that in Dell’s 2011 10-K, the firm announced that it anticipates making between 700 and 750 million in capital expenditures for fiscal year 2012. This figure is significantly higher than capital expenditures for the previous three years and is more consistent with the levels of fiscal year 2008, before the financial crisis. At any rate, I consider increased capital expenditures to be a positive development for Dell (and even if the increased expenditures do not support an expansion, knocking 300 million off of free cash flow would still produce an ample free cash flow yield of 16.6% on Dell's ex-cash market cap).
When I asked certain people of my acquaintance about Dell and why they thought its multiples were so low, their responses were predictable: No exciting new product lines, no mobile products, nothing that captures the consumer’s imagination. This may be true, but all it states is that Dell lacks a good story. However, the lack of a story does not negate the impressive numbers that Dell is producing, and speaking for myself, I will take good numbers over a good story any day.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in DELL over the next 72 hours.
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