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The race to corner the artificial intelligence (AI) market is on. Hyperscalers like Alphabet (GOOG)(GOOGL), Meta (META), Amazon (AMZN), Microsoft (MSFT) and Elon Musk's xAI are all spending billions as companies around the world leverage generative AI, robotic process automation, and machine learning to improve efficiency in a hyper-competitive business world.
Musk believes AI will make the giant leap from generative (creating content or performing tasks using huge data sets) to artificial. general The report estimates that Musk will have artificial general intelligence (AGI) within two years, while others predict it will take longer. It doesn't matter whether you think Musk is right or is being overly optimistic, whether you applaud him or cringe at him (or anything in between).
The goal for investors is to find companies that benefit from massive investment. That's why I recently initiated a position in Dell Technologies (New York Stock Exchange: Dell).
Demand for tailwinds
Statista predicts Global data center revenue will increase by 50% In five years, the company will grow from $416 billion this year to $624 billion in 2029, and server and storage sales will increase from $176 billion to $308 billion. This is a huge opportunity for Dell.
Much of this will come from hubs built by “hyperscalers” like those mentioned above. Dell is a major supplier to the xAI initiative seeking to build the “world’s largest supercomputer” and will provide server racks. You can read more about this here hereA key competitor, Super Micro Computer (SMCI), is also involved in this project, and its problems could put Dell in the driver's seat. Success in this regard will translate into future contracts.
Super Micro Computer's woes are a boon for Dell. Super Micro's stock plummeted when the company delayed filing its annual 10-K report, and its reputation took a hit after a short report from Hindenburg Research.
It doesn't matter if the report is revealing or a smear job. After these events, would you rather be a salesman for Dell or SMCI?
NVIDIA (NVDA) and Dell are also well integrated with the Dell AI Factory and Helix Projectwhose objective is to accelerate the adoption of AI technology.
These powerful partners will enable Dell to rapidly expand its market share.
Impressive results
Dell's fiscal second quarter results are encouraging. Revenue increased 9% year-over-year and 13% sequentially, as shown below.
Operating income and free cash flow were also strong, at $1.3 billion each. But the best news is in the details.
Infrastructure Solutions Group (ISG) (serving its data center customers) sales reached $11.6 billion, up 33% year-over-year, driven by an 80% increase in server and networking revenue, as shown below.
Dell
The increases are a direct result of growing market demand. Below is a selection of CEO Jeffrey Clarke's comments (emphasis mine):
At ISG, our AI server orders and shipments again increased sequentially. Our unique ability to deliver cutting-edge air- and liquid-cooled AI servers, networking, and storage… continues to resonate with customers. Order demand was $3.2 billion, driven primarily by Tier 2 cloud service providers. It is encouraging that we continue to see an increase in the number of enterprise customers purchasing AI solutions Every quarter.
Enterprises remain a significant opportunity for us as many are still in the early stages of AI adoption… We shipped $3.1 billion worth of AI servers in the second quarter… the AI server backlog remains healthy at $3.8 billion.
Most excitingly, our AI server portfolio expanded again to Tier 2 CSPs and enterprise customers in Q2 and It has now grown to several multiples of our order book..
Dell's strong market, industry experience and the challenges of its competitors make it a great fit, but there are other considerations as well.
What could go wrong?
All stocks have risks, and Dell is no exception. The industry is competitive, and the highly cyclical PC market is its most important business. Some are predicting a new upgrade cycle driven by AI-related operating system and performance upgrades, but this is speculative at the moment. Consumers are clearly feeling the pinch from high interest rates; however, rate cuts are expected soon.
Is Dell a stock worth buying?
In addition to the huge potential of its ISG group, Dell shareholders have other advantages. The dividend yields 1.5% after a healthy 20% increase this year, and management aims to grow it at least 10% annually through fiscal 2028. This will give current investors at least a 2% return on cost, regardless of increases in the share price.
The company is more prolific in share buybacks, with $700 million in the most recent quarter and $3.6 billion, or 4.5% of current market capitalization, over the past twelve months. As shown below, the outstanding share count is rapidly shrinking as buybacks increase.
Dell can do this thanks to its prolific free cash flow, which was $24 billion over the previous five years and $1.3 billion last quarter, a run rate of $5.2 billion.
The stock is trading at a higher price-earnings (P/E) than its recent averages and competitors such as HP (HPQ), as shown below.
However, Dell's recent results have been more impressive and analysts are optimistic, with an average price target of just $150 per share, or 32% above the current price. Moreover, Dell could beat analysts' EPS estimates if it gains market share due to the problems at Super Micro or if demand is even stronger than anticipated.
Many stocks have already joined the AI hype, but Dell is still trading at a reasonable valuation and 36% below its recent high. That's why I took a position when the stock dropped to $100 per share and still consider it a good long-term buy.