The Drip Portfolio
More important, however, will be the company's forward guidance in the conference call, which was scheduled to begin late this afternoon. In the second quarter, Intel's shares rose during the weeks following its EPS shortfall because management shared enthusiasm for the second half of the year.
Generally, the positive sentiment wasn't misplaced. The company shipped record volume of CPUs this quarter as demand for Personal Computers continued to rise and prices for the boxes continued to decline. With falling PC prices, however, Intel's average selling price (ASP) per chip sold dipped again even though some Intel watchers expected ASPs to rise. The company's product mix -- it is selling more high-end chips while reducing the cost of producing its low-end chips -- helps ASPs hold up. This early after the report, the decline in ASPs is the only slightly disappointing item in the report in my opinion.
As the Q3 press release shows, most of the metrics of Intel's business continued to improve or hold steady. Consider the profitability level of the company this quarter compared to the third quarter of 1998, with the second quarter of this year thrown in for good measure.
3Q99 2Q99 3Q98
Gross Profit 58.7% 58.9% 52.5%
Operating Profit 34.2%* 34.3% 32.0%
Net Profit 25.9%* 25.9% 23.1%
*on a pro forma basis that excludes one-time acquisition and other charges
Margin-wise, the quarter was flat with the second quarter, both of which straddle the typically slower summer months. However, both quarters improved markedly from Q3 (and the other quarters) of last year. In 1998, Intel was under assault in the emerging low-end PC market, forcing the company to sell more expensive chips at cheaper than anticipated prices. In contrast, now Intel is generally leading the low-end market with chips that are inexpensive for it to produce, while its new high-end offerings boost margins and cost-savings -- including a move to smaller micron technology -- help as well.
At the end of the second quarter, management provided guidance of gross margin of 60% plus or minus two points for 1999. They also predicted that Q3 sales would rise "slightly" (sales rose nearly 9% sequentially) and that Q4 would be strongest. We'll see if any of this changes in today's conference call. From the press release, it doesn't appear that this guidance will change.
Now consider the company's balance sheet.
3Q99 2Q99 3Q98
Cash N/A $3.5B $2.9B
Investments $11.8B* $6.6B $5.5B
Long-term debt $884M $666M $583M
*this is combined cash and investments, because the detailed 10-Q isn't yet available.
Cash and investments have grown continually at Intel as free cash flow has poured into the company's coffers at a rate higher than it can invest it into 1) new external businesses, 2) new internal ventures, and 3) its existing business.
Now let's consider some history. Since 1989, Intel's sales and cost of sales have grown while gross margin has fluctuated as follows. High and low points are in bold.
Sales Cost of Sales Gross Margin
1998 $26,273 $12,144 53.77%
1997 25,070 9,945 60.03%
1996 20,847 9,164 56.04%
1995 16,202 7,811 51.78%
1994 11,521 5,576 51.60%
1993 8,782 3,252 62.96%
1992 5,844 2,557 56.24%
1991 4,779 2,316 51.95%
1990 3,921 1,930 50.77%
1989 3,127 1,721 44.96%
Sales have risen every year since 1989 while gross margin has, on average, trended higher as well. The low point was 1989 and the high was in 1993, though the past three years have been the best combined three years. This year, gross margin should land around 60% to 61%, near the company's high. Sales will easily top $30 billion in 1999.
The company's all-important cash flow continues to improve as well. Cash flow serves to put a value on a stock. All sorts of "goodwill value" exists (how strong is the company's brand, how deep is the moat around the business, how genuine are the smiles in the annual reports), but positive cash flow is what matters over the long run. Eliminate a great brand's cash flow and see what happens to the stock. Intel's cash flow per share was $2.51 in 1998. It should top $3.25 this year. The estimates for the year 2000 exceed $3.80 per share.
All summed, it wasn't a stunning quarter, but it was a good quarter and Drip Port's long-term investment theory -- our reasons for buying and holding the stock -- remain well intact. Twenty years is our holding objective as long as the business excels. Thus far, 10% through our initial holding period, the company is performing well above average and the stock is greatly outperforming.
At $76, Intel trades at 33 times recent 1999 EPS estimates and at 28 times year 2000 estimates. Perhaps more significantly, it trades at 23.5 times this year's estimated cash flow, and at 20 times next year's estimate. We're happy holding and we will be investing more money periodically, commission free, as usual.
Intel's third quarter conference call can be accessed from Intel's investor relation page. As usual, we will have a summary of the conference call tomorrow (the call begins soon). The conference call recording can be heard tonight and through October 15th by picking up ye olde phone and dialing (719) 457-0820 and then entering confirmation number 750229.
To discuss Intel, please visit the Intel message board or the Drip Companies board.
Until tomorrow's conference call summary, Fool on!