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Debunking the Intel Bounce


Higher revenues, earnings due to fundamental misunderstanding.

The following is a hedge fund's analysis of Intel's (INTC) earnings report last night. Technology stocks have risen much more (as they might today) than the rest of the market over the last month or so.

The reason I'm sharing this analysis with you is it goes into why the revenues and earnings were better than expected: even though end demand for technology products is falling, suppliers and distributors, thinking that the economy is bottoming like most investors, have ordered more from INTC.

This analysis shows this is due merely to an inventory build that is likely to be taken away as it becomes clearer that end demand is not picking up. A higher stock price therefore creates more risk. Always try to understand why something is happening.

"INTC reported second-quarter revenues of $8 billion and EPS of $0.18 versus expectations of $7.5 billion and $0.12 driven by higher MPU and chipset units. Demand was driven by China with US relatively better than first quarter and Europe still weak. Guidance is for revenues of $8.5 billion and EPS of $0.24 versus expectations of $8.1 billion and $0.21. I note that INTC is guiding third-quarter revenues to a much wider than usual range (up 1% to up 11%) given what the company sees as "a much wider range of outcomes in this third quarter than what they normally would see" given uncertainty in enterprise and back to school demand and a relatively soft start to the third quarter. I note that September is typically a back-end-loaded quarter with the month of September accounting for the majority of the quarter's sales. This coupled with the company's commentary of unevenness in demand gives rise to the company's wide range of guidance for the September quarter.

"The company expects ASPs to decline quarter over quarter in third quarter, driven by an unfavorable mix of more consumer versus enterprise (echoing DELL's comments yesterday), a mix shift to lower ASP netbooks versus notebooks, and aggressive unit pricing pressure from OEM customers (also in line with DELL commentary). Interestingly, INTC management discussed their expectations for ASPs for the next few years which they believe will be in secular decline as notebook unit share (which carries a higher margin) has peaked and lower priced netbooks will increasingly take unit share. This is the first time that INTC has discussed such a phenomenon and, if true, will likely structurally pressure margins (and the stock) over time as INTC stock has a very high directional correlation to its gross margins.

"Near term I note that second-quarter revenue growth of 12% quarter over quarter marks the greatest second-quarter quarter-over-quarter growth the company has seen in the last 20 years. In fact, there has been only one other time in the company's history where they have grown greater than 12% in second quarter, which came in second quarter of 1988 when the company and the PC industry was much younger and more of a secular grower.

"While superficially this may seem positive, recall that the company and the PC industry is now more mature and cyclical in nature with greater divergence from normal growth only increasing the likelihood of a cyclical peak and a ensuing downturn in demand especially given the anemic demand profile of PC growth currently. With a 5-year second-quarter revenue growth average of down 3.4% quarter over quarter, the up 12% quarter-over-quarter growth posted in second quarter 2009 markedly increases the probability of INTC over-shipping PC demand, which is running flat to up 1% quarter over quarter in second quarter, and giving rise to second-half estimates that are likely too high.

"This is very similar to the 2001-2002 cycle where, after missing consensus estimates for most of 2001, INTC reported third-quarter 2001 revenues in line with estimates and guided for fourth quarter revenue growth of down 1% quarter over quarter.

"In January of 2002 when the company reported fourth quarter 2001, INTC beat guidance and estimates due to inventory replenishment with revenue growth of up 6.7% quarter over quarter versus expectations of down 1% quarter over quarter and guided +:02 in line with estimates of down 5% quarter over quarter. In April of 2002 when the company reported first quarter 2002, estimates were raised again as INTC reported first quarter 2002 growth of down 3% quarter over quarter versus estimates of down 5% quarter over quarter and guided to second quarter of down 1% quarter over quarter versus estimates of down 4% quarter over quarter.

"However, given that end demand remained anemic, and after 2 quarters of beating estimates due to the company over shipping demand, INTC eventually missed second quarter 2002 guidance with revenue growth of down 6.5% quarter over quarter versus estimates of down 1% quarter over quarter and eventually missed third-quarter 2002 estimates before finally beating estimates in fourth quarter 2002.
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Position in INTC, AMAT, KLAC, NVLS
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