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VIDEOIntel's Coming Margin Fluctuation Not a Stock Sell Signal
By
Bob Faulkner Jul 14, 2010 9:00 am
Company will see some margin fluctuation relative to its process ramps, but that's a good thing and will bear fruit for it down the road.
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Despite the numbers, you’re going to see some naysayers out there today and their arguments will be “peak margins” and "below seasonal guidance."
The peak margin argument is quite common and just like peak oil and peak everything its easy to claim and difficult to prove. More importantly, it’s been asserted since Intel crossed the 60% threshold last December and we see how well that worked out.
Intel’s gross margins have a lot of puts and takes each quarter, some of which are under the company’s control and some of which are not. First up is product mix.
The company sells a complete array of microprocessors filling sockets from the least expensive netbook to very high-end servers. It doesn’t take Albert Einstein to understand that the high-end parts carry higher margins. Consequently, when we see strong corporate purchasing as in the second quarter, it contributes positively to gross margins. The flip side of that comes in the second half of the calendar year with back-to-school and holiday purchases by consumers. Those components tend to carry lower margins.
Another major contributor to margins is COGS (cost of goods sold), and that figure is dominated by its depreciation charges. A leading edge fab today runs about $4.0-$4.5 billion and the bulk of that figure is in wafer fab equipment with a four-five year depreciation schedule. This creates two huge swing factors for the company.
1. When it commences manufacturing at a new process node as its doing now with 32nm the early wafers coming out of the fab tend to have lower yields and, therefore, higher COGS. But as yields ramp, COGS decline. Think of it as a temporary inconvenience for a long-term improvement.
2. The big worry relative to COGS is what we saw in late 2008. As demand dropped the company’s fabs were underutilized. Starting fewer wafers reduces the variable costs, but that huge depreciation charge has to be borne by fewer wafers. That’s the cyclical drag on margins that hits everyone.
At this point in the business cycle, Intel will see some margin fluctuation relative to its process ramps because it’s accelerating its 32nm production. That’s a good thing and will bear fruit for it down the road, not a sell signal on the stock.
The bear case based on “revenue guidance below seasonal norms” is actually funny when you look at the context. The second-quarter seasonal norm is a sequential decline of 2%, not a 5% increase. If Intel had delivered seasonal quarter, the guidance for the third quarter would be well above normal seasonality. Bears want to be bears and they’ll find the “facts” to support their position.
The bottom line on Intel’s quarter is that it demonstrated its dominant manufacturing prowess. The winds shifted favorably and that put a lot of icing on the cake. Those same winds will move around, but they don't change the underlying fundamentals.
No positions in stocks mentioned.
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