Dell's stock rally faces reality check as AI demand fails to keep pace

Investors in US tech giant Dell are questioning the soaring 90 per cent rally in the stock, wondering if the high price justifies growth that has yet to materialise. According to a Bloomberg report, the surge, propelling the personal computer giant's shares to a record high by the end of November, was driven by optimistic expectations of a boost from artificial intelligence (AI) demand.

However, Dell's recent third-quarter report revealed that the much-anticipated AI growth is not on the immediate horizon, prompting cautious sentiments among investors.

The stock, currently trading above its five-year average at about 10 times forward earnings, has encountered headwinds as Dell’s third-quarter results indicated that the expected AI boost is not imminent.

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Bloomberg cited analysts, like Hendi Susanto from Gabelli Funds, who are adopting a patient approach, stating, “We are waiting to seek a better entry point.”

Susanto further acknowledged the run-up in the stock and emphasised the need for caution in light of the uncertain AI growth prospects.

Mixed signals from Dell’s second quarter report

Dell initially fuelled optimism in August when it surpassed sales expectations in the second quarter and expressed confidence in the long-term potential of servers supporting AI workloads. However, the recent third-quarter results painted a different picture. While Dell recorded $500 million in revenue from high-powered servers, this was insufficient to offset the decline in PC sales.

Morningstar’s William Kerwin, who downgraded Dell to a sell rating in September, warned that the stock is overvalued at current levels, echoing concerns about the company’s ability to navigate challenges in the PC and server/storage markets.

Barclays analysts, led by Tim Long, joined the chorus of scepticism, downgrading Dell shares to a sell-equivalent rating in September. They attributed the downgrade to macroeconomic pressures, anticipating difficulty in the PC and server/storage markets that AI might struggle to offset.

Future growth hinges on AI-Based devices

Daniel Newman, CEO of The Futurum Group, emphasised the crucial role AI-based devices will play in Dell's future growth. “Growth in this area will require a cycle when people are upgrading because AI enables them to do something new on the device,” Bloomberg quoted Newman as saying. He believes that genuine growth won't materialise until AI-based PCs and phones enter the market. However, he predicts this may not happen until the latter half of 2024.

Current consensus projections indicate that Dell's sales will decrease to roughly $21 billion in the fiscal first quarter of 2025 before increasing to approximately $23 billion in the second quarter and continuing to rise through the end of the year. Despite these projections, over 70 per cent of analysts covering the company maintain a buy-equivalent rating, with an average $79 price target, implying nearly 14 per cent upside.

A silver lining in Dell’s solid financial position

While concerns about Dell's growth persist, some investors find solace in the company's solid financial position.

Jack Ablin, CIO of Cresset Capital LLC, stated, “We like companies that have a very sterling balance sheet, don’t borrow very much and aren’t as subject to the vicissitudes of the market and the economy.”

Ablin believes that Dell's robust financials position it well to weather a slowdown, potentially benefiting from the next wave of AI demand. The lingering question remains whether AI will serve as the catalyst to drive the next hardware cycle.

(With inputs from Bloomberg)

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