<THE DRIP PORTFOLIO>
It continues to chip away at industry
by Jeff Fischer (TMFJeff)
ALEXANDRIA, VA (July 13, 1999) -- We paid James Earl Jones a great sum of money to say the following:
"Welcome to Intel, The Second Quarter Results"
After the market closed, Intel (Nasdaq: INTC) reported Q2 earnings per share (EPS) of 51 cents, up 55% from last year's second quarter, but two cents below the First Call mean estimate of $0.53 per share. If we were short-term traders, we might spend the evening thinking about the market's reaction tomorrow, but being long-term owners, we couldn't care much less.
Second quarter revenue rose 14% from last year to $6.7 billion. Although revenue was expected to decline from the first quarter's $7.1 billion, it fell below what many anticipated. The impact of the slower-than-anticipated quarter is being tempered by the fact that Intel, as has been the case in years past, said it expects a considerably stronger second half of the year, most of it arriving in the fourth quarter. Third quarter revenue is expected to rise modestly, and fourth quarter revenue should jump from there. Margins, meanwhile, are holding steady and are even rising despite another decline in the average selling prices of chips.
How can margins hold up? Efficient production and increased cost cutting.
Despite continuing to drop chip prices in order to regain market share in the value PC segment (which Intel has now done), our company has increased margins the past year via lower expenses and improved production. This success results in an even tighter vise grip over chief competitor Advanced Micro Devices (NYSE: AMD), because the more money that Intel can save, the lower it can price chips -- of course. Meanwhile, AMD can't lower prices without losing more money.
Intel's margins look like this:
Q2 1998 Q2 1999 Gross 48.9% 58.9% Operating 27.0 34.3 Net Profit 19.7 25.9
The jump is large.
Last year, Intel was still early in its price-slashing phase, and cost savings hadn't caught up with the lower average selling prices. This year, continued price cuts haven't impacted margins or EPS very much because the company has done so well at containing costs and improving yield -- which means it efficiently produces as many chips per wafer as possible.
An ability to save money and improve efficiency should continue unabated at Intel, and in degrees rarely seen by any company in the world. Intel expects to begin using 300 millimeter (mm) chip wafers by 2002. The implementation of 300 mm wafers should cut high-volume chip fabrication costs by a massive 30%. Before that happens, Intel is moving to 0.13 micron technology on 200 mm wafers, and this should also cut costs by double-digits.
We often hear, and we have said ourselves, that Intel is a difficult business for which to predict future results. That may be true. However, there are few businesses in the world -- if any -- for which you can predict such substantial cost savings with near certainty. Intel stands alone in its ability to continue growing at double-digit rates while cutting production costs by double-digit rates and passing savings onto consumers, thereby putting its competition in a tightening bind.
Intel continues to meet all of our desired qualities for investment: long-term double-digit sales and earnings growth that appears sustainable; an industry dominating position; rising dividend payments; continued share buybacks (Intel bought back 25 million shares this quarter for $1.5 billion, and it has bought $16.4 billion worth of Intel stock since 1990); and many other qualities. Margins, from gross margin on down, have improved considerably from ten years ago, while growth has been the definition of steady:
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
Beyond this past performance, Intel continues to build for the future and -- happily in our minds -- is taking more risks. For the first time since 1981, Intel is moving aggressively beyond microprocessors and into Web server farms, e-commerce, networking, and other largely Internet-centric businesses.
Every quarter, Intel's press release becomes longer as it details the operations of new divisions. If management can parlay its adept ability to create chips efficiently into other business lines, new businesses will be a boon for Intel in the long term, no matter how small they are compared to Intel's primary chip business or for how long they remain small. Building new businesses takes time and involves costs. In 20 years, however, Web server farms (for example) might be a significant slab of Intel's earnings.
Intel's earnings press release and Q2 conference call replay can be heard at the company's Website, www.intc.com. We'll share a Foolish review and our thoughts on the conference call tomorrow. For today, our summary is this: Intel is intact and healthy. Margins remain incredible, the business is swallowing price cuts very well, and the future should be more of the same as Intel maintains (and perhaps grows) market share in all segments. Further expense cutting via new technology and the release of new high-end chips will only help in 2000 and beyond.
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