Intel (Nasdaq: INTC )
Trading at $21.40 as of 10/26/04
I've never been one for those blood-spattered teenage slasher movies. Freddy vs. Jason? No thanks. I'd rather sit through Barney reruns than watch that showdown of fictional creeps. Maybe that explains my similar revulsion for companies that report endless streams of bad news. I guess I'm just not down with the downer crowd.
Yet this time of year unfailingly makes me wonder what profits there are in the worm-ridden corpses of the stock market. That's why I'm picking Intel as a trick, and suggesting you, dear Fool, consider shorting it.
Fellow Fool Rich Duprey says I've made a living covering the doldrums of the chipmaker. Well, Rich, not quite a living, but enough for a few burritos. And with good reason. Just check out what's happened to Intel in the past 30 days:
- It canceled the 4 GHz Pentium chip.
- Inventory issues contributed to a mediocre earnings report.
- And longtime partner Hewlett-Packard (NYSE: HPQ ) sacked the 64-bit Itanium for its lower-end workstation line in favor of AMD's (NYSE: AMD ) Opteron 32-64 bit combo chip.
Worse, AMD has been steaming ahead as Intel has been retreating. Indeed, third-quarter earnings for Intel's longtime rival improved by nearly $75 million and processor sales were 34% higher than last year, a few cuts above Intel's estimated 4-5% growth.
Still, I'll admit that Intel is no typical short. Yahoo! Finance estimates Intel's trailing 12-month free cash flow in excess of $9 billion. Plus, semiconductors are a cyclical industry that blows hither and thither. (Although research suggests the winds are starting to blow colder.) Such unpredictability creates the open situations short sellers typically loathe. Yet there are several things working against Intel that, in this Fool's opinion, makes a short compelling:
Drunk with options, facing an earnings hangover
When it comes to stock options, Intel is like a bloodstained vampire, sucking the life out of owner earnings. During the second quarter -- the most recent for which we have a 10-Q filing with the Securities and Exchange Commission -- Intel would have seen its $0.27-per-stub earnings reduced by 20% had options been expensed. So far, the dilution has only served to transfer wealth from owners to employees. But the impact will be more far-reaching next summer, when the Financial Accounting Standards Board requires options be expensed. Think sales growth will offset the income drain? Think again.
Slowing semiconductor sales
Intel has had a good year in terms of sales and earnings, especially when compared with last year. But the pipeline appears to be getting weaker. Consider the most recent quarter's results, in which sales rose by 8% over last year but cost of goods sold (COGS) rose by 15%. Ouch.
Furthermore, estimates from the trade journal Electronic Business are anything but rosy. Year-over-year global sales growth for semiconductors peaked at 40% from April to June, but that total could be cut in half by the end of this year. The trend will continue into 2005, as growth will slow to as little as 5%. The well may be going dry at the worst possible time.
No margin for error
My biggest concern in all this is that Intel needs to be running a more streamlined, cost-efficient operation. But that isn't happening. Gross margins have dropped for four straight quarters. This quarter's total, 55%, is three points lower than during the same reporting period last year. Less gross profit on higher revenue usually doesn't make for success, especially in a weakening sales environment.
As fellow Fool Bill Mann recently pointed out in an excellent take, Intel's inventory management is barely manageable. What appeared to be a $43 million improvement in inventory was likely erased through write-downs and price reductions, all of which would have been counted under cost of goods sold. And, remember, that number rose by more than $480 million -- in a single quarter.
Folks, this is one spooky company and one scary stock. Trading for an estimated 13 times its free cash flow when compared with enterprise value and 19 times its anticipated future earnings, Intel is still expensive considering weaker global demand and increased competition. And, not only that, momentum isn't on its side. The stock's relative price strength of 14 means that 86% of all other stocks have outperformed it over the last year.
Yet if you can stomach the gore you may find a ghoulish treat in shorting Intel. But going long at this point is asking for a most devilish trick.
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Related commentary on Intel:
- Intel on the Outs?
- Intel's Mongolian Contortionist Act
- AMD: The Little Engine That Might
- HP Spurns Intel
- Intel May as Well Restate Earnings
Fool contributor Tim Beyers just isn't a chocolate kind of guy, except for Kit Kat bars. Tim owns no shares in any company mentioned in this story. You can view his Fool profile and stock holdings here.
The Motley Ghoul's Tricks or Treats represent the opinions of each Fool only and should in no way be taken as the opinion of either The Motley Fool, Inc. or any company in question, or as representative of anyone or anything other than that specific Fool's thoughts. So do your homework, and review The Motley Fool'sdisclosure policy.