Trading Intel? Here Are My Thoughts
Despite some
positive rhetoric and “positive operating metrics” on its January call, it
doesn’t look like Intel’s inventory troubles are behind it.
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The company
reported strong mobile MPU sales at the high end of typical seasonality. Numbers
were definitely “good†this quarter. But I think Intel is setting up for a big
miss in the second or third quarter of this year, given margin expectations and
inventories, which are still above fourth quarter 2003 levels. My big issue with
Intel’s January results is the inventory units and the extent to which the
company may be “managing” its numbers with “zero cost inventory”. Â
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Recall in early
December 2004, Intel had raised its outlook on its mid-quarter update.
Management raised revenue guidance for the fourth quarter to a range of $9.3
billion and $9.5 billion, higher than the previous range of $8.6 billion to $9.2
billion given on its October conference call. Taking the mid points of these
ranges, this was an increase of around 5.6 percent. Management explained that
the increase was driven by stronger global demand for its Intel Architecture
products.
But my big issue with Intel continues to be its inventory levels.
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Excess capacity
is pressuring memory chip pricesA good way to
test for supply/demand balance in the semiconductor market is to watch spot
prices during the last seven or ten days of each month (doubly so at
quarter-end). If prices soften during the last week that indicates memory parts
are in excess. The current theory is that any month-end dumps will be performed
by the smaller (mostly Taiwanese) suppliers. The main beneficiaries will be the
lower-tier PC houses and white box companies since the top PC companies are
locked in with the top DRAM companies.
In a rising market, spot can exceed contract prices and spot going under
contract can be a sign of softening. However, it works only if it lasts long
enough that customers can demand and receive price cuts on their contract
prices. I recall this test failed a couple times over the last two years but
maybe this time it won’t.
With spot prices declining, DRAM suppliers are usually building up inventory
while they “pass” on accepting orders at lower prices. As parts build up, spot
suppliers feel pressure to flush them out to at least record some revenue for
month-end or quarter-end. Hynix was most notorious for this when it was
struggling to re-finance its debt and needed cash to show its creditors, but the
same concept applies to everyone. When prices are soft, nobody wants inventory.
This all gets back to why I think Intel is still in some trouble with inventory
and resorting to financial engineering (zero-cost inventory) to make its
numbers.
So, unless demand in the PC market is well above normal seasonality in the first
half of 2005, which I wouldn’t wager, then I think Intel’s earnings and margins
will come down over next few months.
Now, it could be argued that Intel isn’t necessarily playing games with its
numbers. But even if it isn’t, I’d still be cautious because Intel is still
sitting on near bubble-like inventories and heading into a soft period. I’d be
surprised to see the company’s gross margins above 57 percent the next two
quarters. I think there’s more downside than many others who are taking the view
that the worst of the news out. It will take longer to work through the
inventory build than many are expecting largely due to the timing of demand,
which I expect falls off in the first and second calendar quarters of 2005.
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