Why Dell's stock had its worst day since 2018 despite strong AI demand

By Emily Bary

Investors are 'likely to get anxious relative to the cost of driving the strong revenue-growth trajectory,' JPMorgan says

Investors have been laser-focused over the past year on identifying companies that can bring in meaningful artificial-intelligence revenue, but Dell Technologies Inc.'s latest earnings report highlights the importance of AI profits as well.

Specifically, Dell shares (DELL) fell 17.9% on Friday, despite rampant growth in AI-server shipments and the company's backlog for that product. Part of the selloff could reflect elevated expectations going into that report, but Wall Street is also disappointed by the margin performance of Dell's infrastructure-solutions group, which houses the server business.

The stock suffered its largest single-day percentage decline since Dec. 24, 2018, when it lost 21.6%.

See more: Dell earnings show fervent AI demand, but margin talk sends stock sliding

"While AI does generate incremental gross profits, sales are [gross-margin] dilutive," TD Cowen analyst Krish Sankar wrote in a note to clients.

He said that "the lower profit fall through to the bottom line is a material risk to sentiment and [free-cash-flow] generation," as he maintained a hold rating on the stock but boosted his price target to $155 from $105 in light of a major recent run-up in Dell shares.

That's not to say Sankar will be on the sidelines forever. "We think the stock could be very interesting as we approach the next growth inflection in storage solutions," he wrote, though he and his team "would prefer a better entry point."

Melius Research analyst Ben Reitzes also flagged margins as the "big issue" coming out of Dell's report.

"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.

Still, Reitzes remains bullish on Dell shares, as "margins should still get better from here." That could happen "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."

Reitzes rates the stock a buy with a $186 target price.

JPMorgan analyst Samik Chatterjee wrote that he and his team "expect investors are likely to get anxious relative to the cost of driving the strong revenue-growth trajectory with margins coming in below expectations for both the reported and guided-to quarters."

They further "expect an overhang with investors more likely to monitor execution to the promised margin improvement through the remainder of the year," though they added that "concerns stemming from the choppiness over a 90-day period are overblown with Dell still on track to expand revenue and earnings well ahead of its medium-term target over our forecast horizon."

JPMorgan has an overweight rating and $155 target price on Dell's stock.

AI servers still present long-term opportunities for Dell. "The offset is that all these AI optimized servers pull in a multiplier of revs for other hardware (like storage) and services and financing," Mizuho desk-based analyst Jordan Klein wrote. "Just not seeing a whole lot of that yet and question will now be the timing of when that could create an added layer for [revenue] upside."

-Emily Bary

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05-31-24 1706ET

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