<font color=red>very good observations
"as some fab start-up costs were pushed from 3Q/00 to 4Q/00."
"Marketing wins over technology every time, right?"
"We're frankly a bit sick of the investment gains issue"
08:18am EDT 18-Oct-00 J.P. Morgan (RAGSDALE, TERRY (1-212) 648-9047) INTC INTC.
INTEL: 3Q/00 EARNINGS: COULD HAVE BEEN MUCH WORSE
October 18, 2000
J.P. MORGAN SECURITIES INC. - EQUITY RESEARCH
TERRY RAGSDALE (1-212) 648-9047
ragsdale_terry@jpmorgan.com
Daan D. Coster (1-212) 648-3806
coster_daan@jpmorgan.com
Intel (BUY)
3Q/00 EARNINGS: COULD HAVE BEEN MUCH WORSE; LOWERING ESTIMATES
Earnings Per Share P/E
INTC 52-Wk ------------------ ------------ MkCap
10/17 Rge 12/99 12/00 12/01 4Q/00 4Q/99 12/00E 12/01E Yld ($MM)
---- ----- ----- ----- ----- ----- ----- ---- ---- ---- -----
$36.19 $76-33 $1.17A $1.69E $1.72E $0.42E $0.50A 21.4 21.0 0.4% $242,963
Previous $1.67E $1.77E $0.43E
Note: 12/00 and 12/01 estimates include investment gains of $0.39 and
$0.27 per share, respectively.
3Q/00 Earnings Highlights
ú EPS/revenues at high end of range: Intel reported $0.41 EPS (before
intangibles), three pennies ahead of our estimate and consensus, with
upside driven 2/3 by higher gross margin (64% versus 62% revised guidance)
and 1/3 by higher investment gains. Revenues were up 5% sequentially, at
the high end of the downwardly preannounced range.
ú PC demand not exactly clear: Intel did not go out on any limbs
during the conference call. Management reiterated that a PC demand
collapse in Europe drove the company's weaker 3Q/00 results and largely
refused to be pinned down on the current demand situation, in Europe and
elsewhere.
ú Guidance OK and probably conservative: Management suggested 4-
8% sequential revenue growth for 4Q/00, somewhat more distinct than the
usual qualitative description, and implied that this is a conservative
range (rightly so, given the 3Q/00 miss). Gross margin is expected to
decline a point or so sequentially in 4Q/00, despite higher revenues, on
higher factory start-up costs. We thought the tone was a touch better
than expected and could have been considerably worse.
ú Capital spending plans unchanged: While revenue guidance is
always interesting, it's easily tweaked later, so we tend to find the
capital spending plan a more interesting indicator of Intel's medium-term
outlook on demand. Management made a point of saying that the capex plan
is unchanged; the company is not backing off on any of its rather
ambitious new fab plans for 2000 or 2001.
ú Downward earnings tweaks but staying the course: We are cutting
our revenue and gross margin assumptions for 4Q/00 and 2001 slightly to
reflect a moderate PC outlook and potential margin headwinds. This takes
a penny out of 4Q/00 EPS and a nickel from 2001. Our target price of $46
(previously $71) is now based on 25 times mid-2002 earnings (previously 40
times 2001 earnings). Although we cannot suggest a great catalyst for the
stock, we think the story is sufficiently well hated that it makes no
sense to get more negative now; we maintain our BUY rating.
Intel reported 3Q/00 earnings after the market close yesterday
(October 17), and it was neither a blow-out nor a blow-up. EPS were a
few pennies above the post-preannouncement consensus, and revenues came in
at the high end of management's recently downwardly revised guidance
range. Ironically, the $0.41 EPS were in line with Street estimates
published before the September 22 preannouncement, but with lower
revenues, higher gross margin, and higher investment gains. Gross margin
was 64%, a couple of points higher than Intel guided in its
preannouncement, as some fab start-up costs were pushed from 3Q/00 to
4Q/00. The 3Q/00 numbers were decent and 4Q/00 guidance wasn't bad
either, and at the risk of being wrong for the sixth week in a row, we
think there's a good chance that the stock will be up a bit today.
Rather than rattling on about the quarter that's now in the rear-view
mirror, it's probably more useful to step through the various negatives on
the horizon for Intel and try to gauge their seriousness:
ú PC demand: This is clearly the most important issue for the near
term. Intel managed to "answer" half a dozen questions about PC demand in
various regions without really nailing down its view. Fair enough, as
management could hardly be expected to draw a line in the sand so shortly
after having to reverse itself and negatively preannounce the quarter.
Intel did reiterate that Europe was the real problem in 3Q/00. Europe
grew 4-5% sequentially, about the average for 3Q/00, but based on the tone
of business toward the end of 2Q/00, management had expected unseasonably
strong growth in Europe during 3Q/00 (as much as 20-25% sequentially!).
Business was on plan through the beginning of September and then fell off
a cliff, which management attributed to weakening economic conditions, the
strong Euro, higher oil prices (and related protests and gas lines), and
weak consumer confidence. Management didn't say very much about other
regions, but our sense is that other regions are neither collapsing nor
hitting the cover off the ball. We continue to believe that PC demand is
OK, not great and not terrible, and we will be very surprised if worldwide
PC unit growth comes in much different from the usual 17% plus or minus
two points either this year or next year. In our minds, Intel's actions
on capital spending speak louder than its words on revenue guidance: The
company is maintaining its capex plan and notes that it needs all the
capacity it can get at the moment.
ú Excess supply: Intel clearly committed earlier this year to a
notable capacity expansion to get caught up with demand in
microprocessors, flash memory, and other products. Now, investors are
worried that the recent demand decline will leave Intel (and AMD) with
higher fixed costs, lower revenues to cover those costs, millions of
excess microprocessor units, and lots of pressure on margins. Intel did
build some inventory sequentially in 3Q/00 (still flat in days versus a
year ago), but management suggests that inventory needs to rise further to
maintain customer-friendly lead times and/or upside demand. Channel
inventories remain about flat. Management also says that its
manufacturing cost reduction program remains on track, with cost per
microprocessor unit expected to decline sequentially through each of the
next four quarters. Thus, costs do not seem to be a problem.
ú Market share pressure: Intel faces some significant competitive
issues with AMD. Intel has been executing poorly on new product
development, and AMD has been executing uncharacteristically well. As a
result, Intel's latest 1.13 GHz Pentium III processor had to be recalled,
as Intel pushed an aging architecture to speeds that it was never designed
for. By comparison, AMD is on the cusp of introducing a 1.2 GHz Athlon,
giving AMD an apparent 20% clock speed advantage over Intel, with more yet
to come in 1H/01. Intel confirmed that the reintroduction of the 1.13 GHz
Pentium III has been pushed off another quarter to 2Q/01, leaving
investors wondering how Intel will compete at the high end. Intel's
answer is accelerating the ramp of the Pentium 4, Intel's first new
processor architecture since 1995 (the introduction date of the Pentium
Pro, which was followed by Pentium II and Pentium III iterations). Intel
said that P4 will ramp more rapidly than Pentium II did, but it's hard to
know what to do with that stat: Since the PC market is much bigger today
than it was at the PII launch, the P4 ramp naturally should be faster
measured in raw units. P4 suffers from dependence on Rambus memory
(availability and cost), which would seem to stunt its ramp, but Intel
clearly sees P4 as the answer to its competitive problem with AMD at the
high end. Intel made a point last night of saying that its simplified
roadmap (cancelled Timna and postponed 1.13 GHz PIII) leaves the company
totally focused on P4. Management also said that it is highly confident
that it can ramp P4 on 0.18 micron manufacturing technology to volume
production for mainstream price points, whereas we (and many others) had
thought that Intel would need 0.13 micron for volume P4 production. The
most important point in our minds is that AMD has never successfully
penetrated the corporate PC market, which limits AMD's market share
potential and gives Intel some breathing room for at least a quarter or
two. AMD's value proposition has never been enough to get corporate IT
managers on board, and we doubt that a couple of quarters of performance
superiority will do the job either. Kind of sad but true: Marketing wins
over technology every time, right?
ú Pricing pressure: This is perhaps loudest issue of the moment
other than PC demand. AMD is looking to gain further share, and Intel
said yesterday that it is looking to regain share, so the concern is that
both will use price in pursuit of market share. No doubt, processor
pricing should be more competitive for the next few quarters than it was
in the last few. But neither company seems prepared to shoot itself in the
foot. Intel is clearly in a better cost position, so AMD has to be
careful about starting a price war. In fact, AMD said in its 3Q/00
conference call that it expects to lose share at the low end during 4Q/00
because it faces an infrastructure pricing disadvantage but is unwilling
to cut its prices enough to make up for it.
ú Other income: Intel realized $716 million in investment gains
in 3Q/00 and is guiding to $700 million in 4Q/00. With the investment
portfolio's value down on recent stock market declines, we thought that
management might back off a bit on the gains run rate going forward, but
that didn't happen: The 4Q/00 guidance is $700 million. The total
unrealized gain on the portfolio as of the end of 3Q/00 was $2.9 billion,
so this "annuity" has only four quarters remaining, except that the
portfolio includes a lot of investments in private companies that are
still carried at cost. We're frankly a bit sick of the investment gains
issue, which now accounts for $0.27 of our $1.72 estimate for 2001. But
we're plugging in the annuity in the interest of maintaining consistency
with other published EPS estimates. It seems likely that someday these
numbers are going to be unsustainable, but not this quarter. |
