What Now??? Dell,CPQ,Intel.
[source: S&P p.Wealth- For private use only]
Wednesday March 11, 1998 (11:27 am EST)
Missing the Earnings Forecasts: What Now for Intel and Compaq?
By Kevin Gooley
NEW YORK, Mar. 11 (Standard & Poor's) - After the close of trading on March 4, Intel Corp (INTC) announced that earnings for the first quarter (ending March 31, 1998) would fall short of analyst expectations. The shares plunged about $10 in after hours trading that night, and caused a broad selloff in the technology sector as well as in the broader market the next day. Investors then received another jolt a couple of days later, when Compaq Computer (CPQ) announced that it too would miss analysts' first quarter earnings forecasts.
The announcements have left investors wondering about the outlook for tech stocks, whose stellar performance has resulted in a 217% gain in the NASDAQ Computer index since December 31, 1994, well above the 130% gain in the S&P 500. Intel and Compaq have been two of the biggest contributors to the tech sector's rise, surging 375% and 230%, respectively, during that time.
Personal Wealth recently spoke with S&P Computer Hardware analyst Megan Graham Hackett in order to get a closer look at Intel's and Compaq's situations as well as the outlook for the overall technology sector. In addition to covering the major semiconductor, personal computer and enterprise (large, high-end corporate systems) manufacturers, Ms. Graham Hackett also heads the Technology Group for S&P's Equity Investor Services (EIS) division. She was also recently named EIS's co-director of equity research.
PW: The earnings warnings from Intel and Compaq, coming within days of each other, have investors wondering if demand for personal computers (PCs) is slowing. Do you think that's the case?
[Mohan: well helloooo, we already knew that]
Graham Hackett: No, we don't believe it is.
[Mohan:We don't either.]
An important point regarding these announcements is that Intel's original equipment manufacturer (OEM) customers, which include companies such as Compaq and International Business Machines (IBM), had excess inventory coming out of the seasonally strong December quarter. Compaq, which is Intel's largest customer, did not meet its goal of having only two weeks of sales in inventory, and IBM also exited the year with excess inventory. This was due in part to the fact that these companies are changing the way they use their distribution networks.
Most OEMs in the PC industry use a network of resellers, often referred to as "the channel," to distribute their products. A key change in how they utilize the channel is that they are now asking these resellers to do some of the assembly of the end products. This arrangement would more closely resemble the lower cost "build to order" method used by Dell Computer Corp (DELL).
[Mohan: Oh yeah,they wish]
This change in manufacturing strategies and distribution strategies is complex, and as such we believe helped to cause the current inventory glut in the channel. As these OEMs worked with their distributors to reduce prices and sell this excess channel inventory, their need for Intel chips eased.
PW: So you believe Intel's and Compaq's warnings are more a reflection of inventory issues rather than slower end user demand?
Graham Hackett: Yes. We believe Compaq over-built due to an overly-aggressive sales forecast.
[Mohan: We heard about it too, couldn't care less really.
While Compaq's unit shipments soared 44% in the fourth quarter, which was more than triple the industry average, we believe the inventory simply built up in the channel, and the resellers must now cut prices to move these products. These servers and PCs additionally are now suffering from the fact that they include Intel's older generation chips.
Meanwhile, Dell has indicated that its demand remains on track.
[Mohan:Yeah we heard it too. Way to go DELL]
This is notable not only because Dell is one of the market leaders, but also because Dell utilizes a different business model than most of its competitors. The company builds a machine only after a customer has ordered it ("build to order"), whereas most of its competitors build the computers ahead of time and then ship them to resellers. Dell's direct model, by which it sells its products directly to end users, enables the company to avoid the likelihood that its inventory builds up in the channel.
[Mohan..And that is the way I like it...ah-ha,ah-ha] [You tell'em 'girlfriend'.]
In addition, market research continues to indicate a bullish outlook for technology spending. International Data Corp. (IDC) estimates that information technology expenditures should grow from $752 billion in 1997 to $1.2 trillion by 2002. IDC also expects hardware spending to climb from $338 billion in 1997 to $538 billion by 2002.
[Mohan: Hey don't you know there is more where IT came from]
PW: As the growing popularity of sub-$1000 PCs puts pressure on profit margins,
[Mohan: We don't care really.]
hardware manufacturers are looking increasingly towards the more profitable server market (servers are essentially powerful, high end PCs used by organizations to "serve" files and applications to networks of lower end PCs, which are often referred to as "clients"). How is demand in the server market holding up?
Graham Hackett: Intel does not break down its sales by product line, but based on the information available, overall demand from the server market appears to be on track. However, the server segment was indeed part of the reason for Compaq's shortfall. The issue here was the same as it was in the PC segment: too much inventory in the channel, coupled with the fact that this inventory included Intel's older generation processors and old prices. We believe that once that inventory is flushed out of the channel and as Compaq's distributors adjust to the build to order model, the company should be able to capitalize on continued growth in demand for servers and its dominant position in that market.
PW: What's your outlook for Intel and Compaq?
[Mohan:I know you didn't ask me but my outlook nonetheless is 'Show me the money,honey']
Graham Hackett: We continue to rate both stocks four STARS (accumulate).
[Mohan: tell me 'girlfriend' how do you 'accumulate' without buying?? Are you saying 'buy',if not what the hell is accumulate.]
We feel that the inventory issues causing the earnings shortfall for both companies are short term problems, and strong growth in earnings per share should continue once the channel inventory clears out. It is very telling that Intel attributed the first quarter shortfall to weaker than anticipated near term demand, as many OEM vendors grapple with their changing relationship with channel partners.
However, the second half of 1998 should prove to be very positive for both companies. New technologies, such as digital video disk (DVD), will become more widely used and will need the support of higher end computers to run efficiently. The sub-$1000 computer is not very expandable and as these new technologies become available, we believe corporate and home "power users" will look to higher end computers with Intel chips. On the corporate server side, end user demand still appears to be intact. Both companies should also benefit from the next upgrade cycle asMicrosoft Corp (MSFT) releases Windows NT 5.0 later this year and works with Intel to push NT further into the workstation market. While some investors may be concerned about the potential impact of the Asian crisis, we believe it is a short term problem that will not have an effect on the second half of the year. Longer term, Intel's new Merced chip provides a large upside potential fueling future earnings growth.
PS: Sophomoric/silly comments provided by me at no charge and no disrespect meant for S&P or their 'fine' employees and their 'analysis'. |
