Last week, Intel Corporation (INTC) reported third quarter earnings that were a couple of cents ahead of the Zacks Consensus. Analysts were clearly expecting much weaker guidance, because there were a large number of upward revisions following the announcement.
Third Quarter Highlights
Intel’s better-than-expected earnings were the result of strong revenue performance (particularly in Asia) and an improving mix of high-margin enterprise business, which did not allow material deterioration in the gross margin. Additionally, operating expenses were controlled and declined as a percentage of sales.
Working capital management was commendable, as seen from the increase in inventory turns, despite the softer demand in Europe and North America. While DSOs did go up by 3, we believe this could be a question of linearity and possibly not a reflection of weaker collections. In any case, cash flows remained strong at around $3.5 billion, with net cash at quarter-end coming to $16.7 billion. Intel continues to avoid share repurchases.
Fourth Quarter Guidance
Intel’s revenue guidance was $11.4 billion at the mid-point, with the 67% gross margin, $3.2 billion of opex, $20 million other income and a 31% tax rate netting a profit of $3.1 billion, or 27% of revenue. Assuming 5.7 million shares, we have earnings of around 54 cents.
Agreement of Analysts
Of the 39 analysts providing estimates for the fourth quarter, 31 raised expectations in the last 7 days, while only 2 moved in the opposite direction. Analysts were however, more divided on the following quarter, when only 19 of the 37 estimates were raised, while 6 were lowered.
The last 7 days also saw 35 upward revisions and 2 downward revisions for fiscal 2010. The 2011 revisions were also skewed to the upside, with 23 upward revisions versus just 5 downward revisions.
Magnitude of Revisions
Despite the large number of revisions, the Zacks Consensus Estimate did not really move up a lot. For the next two quarters and fiscal years 2010 and 2011, average estimates went up 3 cents, 1 cent, 5 cents and 4 cents, respectively to 53 cents, 43 cents, $1.99 and $1.94.
The main reason for this is Intel’s lower-than-seasonal revenue expectations, which may be traced to consumer softness in Europe and North America, as well as cannibalization from Apple Inc’s (AAPL) iPad. Still, guidance was better than many had expected, with Intel clearly banking on emerging markets, such as Russia, The Middle East, Brazil and China. Embedded remains a wildcard, with possible opportunities cited including kiosks and in-vehicle infotainment.
The gross margin and tax rate outlook provided by Intel surprised on the upside. Although some analysts were skeptical about Intel’s ability to deliver on the gross margin front, it is hard to rule out the logic behind a strong mix, given the softness in consumer. Additionally, Sandy Bridge write-offs will cease and shipments will ensue this quarter, which are the other positives.
Our Take
Although better than originally expected, Intel’s results for the current quarter are not expected to be remarkable. On the contrary, they will most definitely lag historical trends. We are in agreement with analysts that view Intel’s position as tricky, considering the direction of PC demand, which is moving toward lower-cost devices. Despite management’s pursuit of growth in other areas, we believe that it will be extremely difficult for Intel to reduce dependence on the core microprocessor market, where increased competition and pricing pressure are likely.
Additionally, Intel has made a couple of big acquisitions outside of core competencies, which we believe may have confused investors. As a result, there is currently a good deal of caution surrounding the stock. We think it would be advisable to avoid investment in Intel until there is more clarity regarding the consumer side of the business and the impact of tablets, such as the iPad. Consequently, we have a short-term Sell rating on the stock, as denoted by the Zacks #4 Rank. Our longer-term recommendation remains Neutral.
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