It’s one of the more recognisable names in consumer electronics, millions of us own Dell Technologies (DELL:NYSE) laptops or PCs, yet the Texas-based company is also one of the world’s biggest players in servers, essentially the powerful computers that sit inside datacentres.
Estimates suggest that the average data centre has one server per one square metre of floor space. The Digital Realty (DLR:NYSE) owned Citadel Campus, in Lake Tahoe, is one of the world’s largest and most expensive datacentres. It is a 650-megawatt power capacity sprawl that extends across more than 7.2 million square feet. That’s a lot of servers.
WHY IS IT WORTH BUYING
Dell shares have had a bad run since latest earnings at the end of May 2024 (first quarter fiscal 2025), falling about 23%, but analysts and Shares believe this has created an excellent entry point ahead of what we believe will be a new server upgrade cycle as organisations demand the best AI kit to power their own technological solutions.
Those quarterly results were ahead of forecasts on both the revenue and earnings lines, but the market’s chief worry was with margins. While recognising the issue, Melius Research analyst Ben Reitzes was more optimistic about the future.
‘While component cost pressures were well known, a negative mix shift within storage, pricing pressure in traditional servers and upside in the lower margin AI server category were the issue — and it lingers this year,’ he wrote. Yet Reitzes remains bullish on Dell shares, as ‘margins should still get better from here’. That could happen, the analyst believes, ‘as AI servers scale toward 15% gross margin,’ relative to below 10% in the fiscal first quarter, and as ‘higher-margin storage picks up [sequentially] and more profitable services and financing revenue streams pick up’.
Bank of America also sees Dell capitalising on strong demand for AI servers and analyst Wamsi Mohan thinks AI-server margins ultimately will turn higher. ‘We believe that Dell is receiving a premium for its engineering and value add in AI servers despite not being the price leader of the product,’ he observes.
AI-server margins should eventually come to benefit as higher-margin deferred revenue related to services kicks in, he adds. Plus, higher-margin enterprise customers could make up a greater mix of the company’s business.
Over time, margins are expected to improve due to higher deferred revenue from services and a shift from lower-margin Tier Two to higher-margin Enterprise segments. Bank of America projects that a conservative $15 billion in AI server revenue in 2025 could add approximately $0.54 to EPS (earnings per share), with a bull case scenario of $20 billion in revenue potentially contributing $0.69 to EPS.
Consensus EPS estimates are currently pitched at $7.73 for fiscal 2025 (to end Jan) and $9.14 for 2026, according to Stockopedia data. ‘If margins trend higher over time with liquid cooling, there can be incremental upside as well,’ Mohan says.
WIDESPREAD RECOVERY
The rapid emergence of AI, and its knock-on impact to a hardware refresh cycle is clearly an encouraging lever to pull for Dell, but it is not the only one. Dell’s PC segment also presents noteworthy opportunities, say analysts. Increasingly, they are optimistic about the recovery in PC sales by 2025 due to an aging installed base, the end-of-life refresh for Windows 10, and the availability of AI-installed PCs.
They currently model a 9% unit increase in 2025, although they anticipate a 7% decline in average selling prices.
Dell’s storage business is expected to contribute positively to the company’s margin profile. Analysts foresee quarter-on-quarter margin improvement following a seasonally weak period.
There is potential for growth in storage and networking as AI server attachments increase over the long term, and extra ‘upside could come from a high-end storage refresh driven by the IBM Mainframe cycle’, Bank of America note. In short, Dell is potentially in a 2025 sweet spot where all areas of its business could strengthen in unison.
Ultimately, this leaves Dell exposed to positive revenue and EPS revisions as the months tick by, strong growth in AI servers, upside from PCs, and from a refreshed storage portfolio into 2025. That could well create a sustained and widespread investor rethink of Dell and its stock and put the shares back on track for a return to all-time highs this year of close to $180.
That implies more than 30% share price upside into 2025 yet would still imply a price to earnings multiple of less than 20, assuming no change to earnings estimates. Stockopedia puts the stock on a rolling 12-month PEG (price to earnings growth) multiple of 0.8, right in the growth/value sweet spot.
These articles are provided by Shares magazine which is published by AJ Bell Media, a part of AJ Bell. Shares is not written by AJ Bell.
Shares is provided for your general information and use and is not a personal recommendation to invest. It is not intended to be relied upon by you in making or not making any investment decisions. The investments referred to in these articles will not be suitable for all investors. If in doubt please seek appropriate independent financial advice.
Investors acting on the information in these articles do so at their own risk and AJ Bell Media and its staff do not accept liability for losses suffered by investors as a result of their investment decisions.
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