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Higher Earnings Seen for PC Makers

 


By Hal Plotkin
Silicon Valley Correspondent

Gateway’s first quarter demonstrates that the personal-computer sector is being revived by lower component costs, new higher-speed microprocessors and augmented product offerings. The same factors are expected to help most of the other PC makers post healthy earnings over the coming days, despite the usual post-holiday slowdown in PC sales.

“Overall, the outlook for the sector looks very bright,” says David Bailey, an analyst with Gerard Klauer Mattison & Co., based in New York. “The demand is quite strong, component prices are down, and relative price margins are up.”

Bailey says the leading contenders in the PC sector are showing signs that they will throw off the challenge from low-end computer makers that was seen as a significant threat just a few months ago. Talk of sub-$300 PCs, and even free PCs, had previously led many analysts to question the sector’s ongoing viability.

It turns out there’s less of an appetite at the low-end,” Bailey says. A sufficient number of buyers are balking, he says, preferring the more fully configured higher-end systems that are now available at more reasonable prices.

“It’s taken some of the momentum out of the low-end or free PC thing,” Bailey says. “Consumers want something that won’t be obsolete the minute they bring it home from the store.”

Analysts say leading PC makers, such as Dell and Gateway, are also beginning to reap the fruits of their movement beyond PC sales toward more lucrative higher-margin markets, such as computer servers, storage devices and services, including Internet service.

“We like PC companies to the extent they don’t want to be PC companies,” says Daniel Kuntstler, an analyst with J.P. Morgan, based in New York. “By itself, the PC business is not very attractive. That’s why companies like Dell and Gateway are looking for other opportunities.”

Several leading PC makers are slated to release their earnings reports over the next few weeks. They include Gateway, which released its results on Thursday, and International Business Machines Corporation, Apple Computer, Inc., and Compaq Computer, Inc., which are scheduled to release their results later this month.

Gateway Inc. {GTW}
On Thursday, Gateway reported earnings for the first quarter that were 37 percent ahead of the level for the comparable period a year earlier. The results were in line with First Call Corp.’s consensus estimate for the quarter.


Gateway 52-Week Stock-Performance Chart

The company earned 41 cents per share, as compared with 31 cents for the same period last year, leading several analysts to express positive comments about the stock.

“We feel very strong about the long-term outlook for Gateway,” Bailey says. He cites the firm’s still-growing multi-channel distribution network and continued product innovation as key reasons for his optimism.

Gateway made its name selling direct over the Internet. More recently, the company announced the creation of Gateway stores within a store at about 1,000 OfficeMax Inc. {OMX} locations in the United States, a move that will more than triple the number of Gateway retail outlets.

Gateway also plans to offer a low-cost Internet appliance that uses the Linux operating system in conjunction with online access via America Online. Gateway’s new product enables out-of-the-box Web surfing at a very low cost and without the complexities involved in configuring a traditional PC.

“They are making it easier on consumers in a variety of ways,” Bailey says. “They’ve also found a very cost-effective way to increase their retail presence in places where real estate is quite expensive.”

Gateway has nearly a 9 percent market share in the United States, putting it in third place in terms of total U.S. PC sales, behind No. 1 Dell Computer, and No. 2 Compaq Computer, according to International Data Corp.

International Business Machines Corp. {IBM}
The mother of all computer companies has come back into favor with many Wall Street analysts who say the company may now have just what investors are looking for: steady growth and solid prospects generated by a reliable performer.

“IBM has a reasonable valuation and improving fundamentals,” Kuntstler says. “We definitely have a ‘buy’ recommendation on the stock.”


One-year chart for IBM

IBM’s earnings are projected to come in at 78 cents a share for the first quarter, according to First Call’s consensus earnings estimate.

That is down 34 cents from IBM’s traditionally strong fourth quarter, which included the holiday season, and is identical to the 78 cents the company earned for the same quarter last year.

“Top line, it looks flat,” Kunstler. “What’s really interesting is what is happening under the covers.”

Sales of IBM’s services have been particularly strong, notes Kuntstler, who says the firm must continue to grow services by at least 5 percent a year to maintain the needed momentum.

IBM is slated to release its quarterly earnings report on Tuesday, April 18, after the market closes.

Apple Computer Inc. {AAPL}
It looks like smooth sailing ahead for Apple, which continues to sell its increasingly popular products about as fast as they can be made.


One-year chart for AAPL

Even better for Apple investors, many of the company’s current offerings, such as its G4 computer, are finding favor in high-end graphics and design markets, a lucrative strategy that caters to customers willing to pay premium prices for premium performance.

“At this point, Apple is my top pick in the sector,” Bailey says.

Bailey has a “buy” recommendation on the stock, his firm’s highest rating, along with a $145 12-month price target.

“They’re doing an excellent job, both creating demand and operationally,” Bailey adds.

Earnings are projected to come in at 81 cents a share for the fiscal second quarter ended April 1, according to First Call’s consensus earnings estimate.

That is down 23 cents from the $1.03 Apple earned during the seasonally strong fiscal first quarter and 21 cents ahead of the 60 cents the company earned for 1999’s fiscal second quarter. Left for dead by many people just two years ago, Apple has rebounded sharply under the style and performance-conscious leadership of founder and chief executive officer Steven P. Jobs.

“Apple’s story has been very impressive,” Kuntstler says.

Apple is scheduled to release its earnings report on Wednesday, April 19, at 5 p.m. EDT.

Compaq Computer Corp. {CPQ}
Compaq continues to be the one laggard among the leaders in the PC sector.


One-year chart for CPQ

Earnings are projected to come in at 16 cents a share for first quarter, according to First Call’s consensus earnings estimate. That is down 3 cents a share from the previous quarter and in line with the 16 cents the company earned for the same quarter last year

Several factors, most notably executive leadership changes and an outdated distribution model, have bedraggled the company.

“We’re still on the sidelines on Compaq,” Kuntstler says. “They have some pockets of competitive advantage, but success is still contingent on operational reforms. That leaves the outlook a little bit blurrier.”

“The issue for Compaq remains execution,” agrees Bailey, who has a lukewarm “hold” rating on the stock. “Compaq is still retrofitting old systems. I’ve been impressed with some of the announcements they’ve made, but they’re not there yet,” he says.

Compaq is scheduled to release its earnings report on Tuesday, April 25 after the market closes.

Here’s a rundown of some other recently announced PC marker earnings:

Dell Computer Corp. {DELL}
On Feb. 10, Dell reported earnings of 16 cents a share for the quarter ended Jan. 28.


One-year chart for DELL

Just a few weeks earlier, Dell had issued an earnings warning, telling analysts its bottom line would be adversely affected by higher operating costs and limited component supplies. Operating expenses, for example, were 11.6 percent of revenue during Dell’s most-recent quarter on record, as compared with 11 percent in the same period a year earlier.

Some analysts, however, say Dell’s worst days may be behind the company.

“Dell is doing the better job among PC companies of moving toward the new, more-diversified business model most sure-footedly,” Kuntstler says.

Earnings are projected to come in at 16 cents a share for the fiscal first quarter ending April 28, according to First Call’s consensus earnings estimate. The company also earned 16 cents a share in the year-earlier quarter.

Dell Computer is expected to announce its quarterly earnings on May 11.

Hewlett-Packard Co. {HWP}
Hewlett-Packard appears to be on the rebound, after a slow start selling into the PC sector.


One-year chart for HWP

The company, which long focused almost exclusively on corporate and business markets, has been posting strong gains in the consumer market in more recent months, achieving 30 percent growth in sales to consumers during the fiscal first quarter ended Jan. 31, as compared with the same period a year earlier.

Earnings are projected to come in at 82 cents a share for the fiscal second quarter ending April 30, according to First Call’s consensus earnings estimate.

The anticipated earnings for the quarter ending April 30 are up slightly from the 80 cents a share the company earned during the fiscal first quarter and 9 cents above the 73 cents the company earned for the same quarter a year earlier.

Hewlett-Packard is slated to release its earnings after the market closes on Tuesday, May 16.

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