Intel Poised for Long-Term Gain
Snapshot for first quarter results

by Jeff Fischer (TMFJeff)

ALEXANDRIA, VA (April 13, 1999) -- After the stock market halted its daily convulsions, Intel (Nasdaq: INTC) announced first quarter earnings of $0.57 per share, two cents above the consensus estimate of $0.55. Intel achieved $7.1 billion in revenue during the quarter, up from $6 billion last year and down as expected from $7.6 billion during the seasonally strong fourth quarter of 1998. Intel's sales are expected to top $30 billion in 1999, up from $26.2 billion last year.

Take a look at Intel's sales and cost of sales since 1989:

       Sales    Cost of Sales
1998 $26,273 $12,144 1997 25,070 9,945 1996 20,847 9,164 1995 16,202 7,811 1994 11,521 5,576 1993 8,782 3,252 1992 5,844 2,557 1991 4,779 2,316 1990 3,921 1,930 1989 3,127 1,721

Those are just about picture-perfect results, but, of course, this is a picture of annual results, not quarterly results, which fluctuate readily. The current quarter is no exception. Alongside its quarterly report, Intel shared that second quarter sales should be flat to down compared to the first quarter due to seasonal issues, while expenses could increase 6% to 10%. Also impacting potential results are continually lower chip prices. Just before the quarter closed, Intel and Advanced Micro Devices (NYSE: AMD) lowered prices on many chips again.

The continued concern over declining chip prices might be overdone, however, given that during the tail-end of last year and in the first quarter of this year Intel overcame the impact of lower priced low-end chips.

The sale of new Pentium and Xeon chips during much of the first quarter supported the average selling price (ASPs) of Intel's chips, even though low-end chips are steadily declining in price and will continue to challenge most chip maker's profits. Intel is large enough to be the exception in the chip industry. In fact, Intel's gross margin rose from 58% to 59% this quarter (gross margin represents the amount of money remaining after the cost of sales is subtracted from sales).

Rising gross margin is unusual during the first quarter. The increase came thanks to tight cost controls and sales of high-end, more expensive Pentium III and Xeon chips for server and workstation applications. Intel's 1997 decision to divide its business into market segments continues to prove a very smart move. It allows the company to flood the low-end market with cheap chips to maintain brand loyalty while still making great money on the high-end (where $1,000 chips have 80% gross margins). Meanwhile, competitors including AMD, continue to suffer growing losses on rising sales.

Aside from cheap chips, some investors have other concerns.

Nearer-term investors are concerned that Intel's unit shipments of CPUs declined this quarter compared to last despite the release of the Pentium III, which they expected would increase unit shipments. More importantly, however, is that unit shipments increased year-over-year, while arguably the decline in unit shipments from the fourth quarter is natural following the holiday season and the relative lack of hype surrounding the Pentium III. The Pentium III is similar to Windows 98. A person needn't buy a Pentium III immediately, but the chip will be another cash-cow for Intel (for as long as its product life, which may be 18 months), and it will be a highly profitable chip.

This fact might remind investors of an important point.

Intel enjoys a near-certainty regarding the acceptance of each generation of its products that most companies can't boast. The market doesn't seem to fully appreciate the fact that -- given its distribution and production dominance -- Intel has been able to successfully introduce any new chip it creates and, barring disaster, this will continue. The computer market now absorbs new Intel chips without difficulty or commotion. The new chips are now less exciting than in years past because older chips are very fast already, but that doesn't mean new chips won't be successes. The Pentium III will be a success with little fanfare. That the first quarter wasn't a blowout doesn't remove the chip's long-term near-certainty.

Intel is hoped to earn $2.34 per share in 1999, putting the $60 stock at 25 times estimates. Regarding its long-term war chest, Intel's cash balance leapt to $10.5 billion this quarter from $7.6 billion last year. Intel continues to gain strength while competitors continue to become financially weaker.

However, Intel's stock could go anywhere in the near term based on the concerns that we mentioned: news (that isn't surprising) about the lower second quarter; the incessant concern about lower-priced chips (Is it overdone? Intel is in the catbird seat); and the processor unit shipment concern (even though shipments were up year-over-year). The final concern isn't about the future, but the quarter just ended: estimates called for $7.5 billion in revenue and revenue reached only $7.1 billion. Higher than expected gross margin, lower costs, and higher interest income (on its massive cash and investments) allowed Intel to top earnings estimates on lighter than expected revenue.

Those concerns cited, long-term investors are focused on the long term. If Intel is able to continue its current segmented market strategy with these types of profits, the Drip Port should be sitting pretty years hence. To read details of the first quarter press release, please visit Intel's website. From there, you can also listen to a replay of the conference call and learn about the April 22 Intel analyst meeting that we'll cover.

All in all, it was a decent and unsurprising quarter (except for gross margin, which was surprisingly higher). We'd send money to Intel every month if we had more than $100 to distribute, and if it wasn't already our largest position. We should have more on Intel tomorrow following the conference call.

Also tomorrow, Johnson & Johnson (NYSE: JNJ) should report first quarter earnings of $0.80 per share. The company is expected to earn $2.98 per share this year. The stock has been strong since January, rising from the low $80s to as high as $99.

Analyst firm Warburg Dillon Read raised its target price for Johnson & Johnson to $120 per share today from $100, while reiterating its buy rating. The firm reported that it predicts an acceleration in sales growth to 12% to 13% for the year versus 4.5% growth posted in 1998 (we wrote this same thing in December). A rebound in sales growth in the Professional Division and continued strong pharmaceuticals growth should help. The firm also stated that even though J&J only has three new compounds slotted for launch through 2000, it should fill product offerings by in-licensing and acquisitions.

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