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Intel: Too Much, Too Far, Too Fast

In this second article by Karl, he examines Intel’s quarterly results and is not as excited as the market. Why? Layoffs. Intel excels at cost management – good for Intel, but not a sign of healthy economic recovery. – Ilene

Intel: Too Much, Too Far, Too Fast

Courtesy of Karl Denninger at The Market Ticker

Intel, quarterly resultsAnd too euphoric:

SAN FRANCISCO (Reuters) – Intel Corp’s quarterly results and outlook blew past Wall Street forecasts on better-than-expected consumer demand for PCs, especially in Asia, setting an auspicious tone for the technology sector.

Uh, well….

Sure, if you just read the PR on the earnings.

Someone filed that story before the conference call, or simply ignored it.

The strong growth came in Asia, specifically China, which blew out a huge stimulus program.  Ok.

But it was specifically stated on the conference call that US consumer sales were weak, and repeating what DELL said earlier, so are enterprise sales.

The quote that was chosen is rather humorous:

Smith told Reuters that computer markets were strengthening and there were "pockets of relative strength" in consumer PC markets, as well as in the Asia Pacific and in China.

Pockets of relative strength.

Yes, there are.  Netbooks in particular are relatively strong – a new, very-low-cost alternative to laptops.  $300, 400, 500 machines – not the $1,000+ machines previously sold, and they’re replacing the demand that used to be filled by those $1,000 machines!  That’s not so good.

Neither is this:

Executives warned that the corporate market remained weak, and Intel does not expect much change in the second half.

Heh wait a second – I thought this was a bullish report for capital spending and the chip sector?  No?  IBM’s primary market is to enterprise customers, not consumers.

The bigger problem for Intel is its P/E – now well over 20, its just too high – unless we get a very strong economic recovery.

If you’re in the Dennis Kneale camp on that, have at it.  I’m going to pay close attention to the reaction in the real market tomorrow when the stock opens for trading by the pros – not the aftermarket daytrader games of the evening, with most of that volume happening before the conference call began.

I admit to being surprised by my first glance through the earnings release.   I sure couldn’t figure out how those numbers got hit, with the exception of margin expansion – that was easy: layoffs.  It was only when I went through the full PDF, all 10 pages, that it became clear.

Sequential revenue was up $879 million dollars.  But compared to a year ago it was down $1.4 billion – and remember, the recession began in December 2007!

So no, Dennis and the rest, this earnings report does not tell us that we "turned the corner."  Quite to the contrary; it tells us that the recession is deeper now (for Intel) than it was in the second quarter of last year. 

Additionally, selling price, even excluding the Atom, was down slightly on a per-piece basis, telling us that customers are "shifting down" the price scale.

Also important was guidance: The firm intends to continue to spend heavily on R&D (good), up slightly.  It expects a "seasonal" expansion in demand and revenue (in other words they believe people will still buy computers to go back to school, etc.)  But capital spending is expected to be down by 10% or $500 million, which does not bode well for expansion of output capacity (nor for semiconductor fab equipment suppliers!)

Some of the improvement in results also appears to be a fairly normal inventory shift – about $240 million of it, in fact.  Not exactly small potatoes, and backed out of the results the luster dims a bit.

One thing cannot be argued with – enterprise efficiency.  Gross margin expansion may not be good for the fired employees (when that’s how it happens) but one cannot argue with the impact on the balance sheet – it is clearly and without exception positive.  Let’s give credit where due; this is one place that Intel excels, and they’re not losing their touch in cost management.

The other interesting split is the business mix – Asia went from 51% to 55% of revenue from last year, while Japan and the Americas remained the same.  Who lost ground?  Europe.  Do we have a little problem brewing over in Euroland perhaps?  Hmmmmm…. some of this may be related to the EU fine, but I’d love some more color on that.

Near the bottom of the report is, in fact, where that margin expansion came from in stark relief – the company went from 82,500 employees last quarter to 80,500 this quarter – they laid off 2,000 people, or about 2-1/2% of their staff.  This isn’t a big number, but its real, and it certainly contributed to gross operating margins.  Yes, even mighty Intel is not immune to the layoff monster.

Finally, on the last page, we find the y/o/y scoresheet, and the basis of my call: from Intel’s perspective, the recession is simply not over.

In what they call the "Digital Enterprise Group" (PCs, servers, etc) revenue is down 17% from Q2/2008 for CPUs and 30% for chipsets and motherboards (more on this in a second.)

In the mobile processor segment revenue declined 7%, with chipsets and subassemblies down 12%.

The chipset and motherboard revenue decline in the "primary" group is, in my opinion, quite significant.  Intel is known as a premium board and chipset; I own several.  They tend to be toward the high end of the price spectrum, but are high-quality as well.

These are the boards that go into servers and enterprise-class machines – most home users don’t wind up with them simply because there are much less-expensive products from other manufacturers that will work with Intel’s processors.  Assuming Intel hasn’t abandoned that market (I doubt it!) this would imply a very significant deterioration in server and enterprise system sales – far more than the topline decline from 2008 to 2009 would otherwise suggest.

In fact, it implies rather strongly that there may be as much as a thirty percent decline in enterprise-class shipments compared to 2008.

"Green shoots" eh?

Uh, no.

Without CapEx coming back any believed "recovery" will be fleeting at best. 

This is not a bad report, but the embedded reality on business-class sales, which was born out in comments on the conference call and echoes what DELL said earlier in the day, paints a rather dark picture.

Bottom line: Intel knocked the cover off the ball with superior business management, not on the prospect or hint of economic recovery.

Invest accordingly.

Disclosure: Took a small front-month lottery play on PUT options prior to the close and, it appears, lost the bet.  C’est la vie.

Top Photo:  2007Computex NYNY Intel Umbrellas, by Rico Shen, photo and license at Wikipedia.


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