Intel Is It?
...despite negative nellies, we got a winna'
by Jeff Fischer (JeffF@fool.com)
JUPITER, FL (August 13, 1998) --Did somebody say Intel?
Yes, for a few reasons, it's time for an updated look at Intel Corp. (Nasdaq: INTC). This week has been spent on Campbell Soup rather than banks, but that turns out to be rather fortuitous. Last Friday, we provided phone numbers and web links to our top five banking considerations. I've since called each company for updated DRP information and financials. Of course, it takes at least a few days for this info to arrive, and though it isn't vital, it'll be nice to have before we delve back into the banking world next week. In the meantime, Campbell needed to be attended to this week and now we can talk about Intel. Let's attempt to look ahead at what might be happening at the company before it actually does happen.
Intel, our largest holding, is our only company that has seen its year-over-year sales growth decrease in recent history. Sales have fallen sequentially every quarter since the fourth quarter of 1996. In fact, this year Intel is expected to post a 21% decline in earnings per share compared to last year. So why, after announcing second quarter revenue of $5.9 billion and net income of $1.2 billion, has Intel's stock been rising? Believe it or not, Intel is actually handily beating the market this year. Having crossed the January 1 start-line at around $70 per share, Intel is (as of Wednesday's close) up 22% against an 11% gain in the S&P 500.
Bravo, Intel.
Much of the gain has come in the past six weeks despite the news of another flat quarter and warnings of the same for the third quarter of 1998. What is pushing the stock higher, though, is the outlook for late 1998 and for 1999. Stocks usually move in anticipation of future performance rather than on past events, and Intel's future is beginning to show some "rising light," as it were, at the end of a tunnel that has been descending to darkness for six quarters.
(Step into the light! Step into the light, Intel!)
Yet, some skeptics continue to expect weak earnings again in 1999 (earnings of around $3.10 per share, as is expected for this year as well), due to declining microprocessor prices in the midst of competition and a growing low-end computer market. So, will the skeptics prove correct?
Increasingly, it appears not.
Intel's year-over-year sales comparison actually improved in the last quarter to near breakeven (flat sales), and it finally appears that Intel might crack into higher sales numbers (even record high) in the coming few quarters. Revenue estimates for the current quarter stand at $6.1 billion, while fourth quarter estimates are $6.8 billion. Then, in the first half of 1999, it's expected that Intel will first top $7.0 billion in quarterly sales. Revenue next year, in fact, is expected to grow to nearly $30 billion from an estimated $25 billion in 1998 (that's flat with 1997).
Intel could grow sales even in the face of steeply lower CPU selling prices because, well, for one, prices appear to be stabilizing. Intel's average selling prices (ASPs) for its Pentium line of chips were nearly flat in the second quarter compared to the first. This follows a few quarters of steadily lower ASPs. Prices appear to be stabilizing now (lo and behold, right around the 50% gross margin that management aims for), while Intel's costs are under better control than anticipated and new higher-margin sales (the Xeon chips) are ramping towards a bright 1999.
It's estimated that Intel is operating at about 78% of its capacity. As a result, the company has slashed its capital spending for the year by about 10%. In the current quarter, the spending run-rate should decline by 25% compared to last year. Also, the company is moving towards 0.25 micron (meaning more chips per wafer, and less cost per chip) more quickly than expected, pointing towards heavy use of 0.25 in the second half of 1999. This represents more cost savings and potentially higher margins. In fact, even long before 0.25, gross margins are expected to climb. After declining every quarter since the first quarter of 1997, gross margins should increase this quarter and increase further to end the year.
Stocks almost always perform better when margins are improving rather than declining. During the entire time that Intel's margins were slipping, the stock drifted. That means we just went through six quarters of declining margins alongside a relatively flat stock. This has happened in the past as well, and the company lived through it to see a fruitful recovery. Beginning in 1993, gross margins declined from 62% to 52% by the end of 1994, while the stock remained flat. By early 1995, margins began to expand and the stock moved from $15 to $30 in six months (the market was strong that year, admittedly -- but not that strong!).
Microprocessors constitute 74% of Intel's revenue. Currently, the Pentium Pro and Pentium II are the biggest sellers, with expected sales volume of nearly $14 billion this year. Gross margins on this line should be about 57% this year and 56% next year (hardly representing weak margins). Next year, some $17 billion worth of these chips could sell. Meanwhile, the basic Pentium line is still expected to generate over $4 billion in sales this year with gross margins of above 60%. By next year, sales of these older chips should all but dry up, but the big boost in 1999 should come from the Xeon chip (and in 2000 from the Merced chip). Over $3 billion worth of Xeon product could sell next year at gross margins of above 70%. Overall, Intel's gross margins could be in the mid-to-high 50s again next year, if all goes well, bettering management's ambition of 50%.
Despite many negative press articles on Intel this year -- alongside a business that has appeared to be weaker rather than stronger -- Intel's business is actually in a class all its own. It's far from suffering a collapse or a long-term letdown. Having gotten through six quarters of "lackluster" performance (earning billions of dollars), now it's thought that upside surprises are more likely than negative ones. So, the stock has been rising.
Of course, the company will continue to see competition. Puppies will nip at its heels and take away small bites of market share. It's difficult to stop that from happening when a company has 80% of the market. Intel is easily still the one to own, though.
Finally, when you consider that one week's worth of inventory reductions by PC makers would result in a whole $0.10 per share of lost quarterly earnings at Intel, you realize just how sensitive the business is to near-term PC demand. Considering that, you need to continue thinking of Intel on a long-term basis. Thankfully, as Fools, we do.
The stock trades at 22 times 1999 earnings estimates of around $3.80 per share. As always, those estimates are merely that -- estimates. Invest Foolishly. Invest for the long-term in leading companies.
Fool on!
Jeff Fischer
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