Joe Osha@Merrill:''Q2 looking tougher''
by: skeptically2 06/11/06 02:22 pm
Msg: 871633 of 871639 (Yahoo INTC board)
09 June 2006
Q2 looking tougher
�� Lowering estimates for Q2 and 2006
We think there’s material risk to Intel’s Q2 outlook in light of recent developments,
and we are reducing our estimates for Q2 and the remainder of the year. Our
thesis in terms of the company’s competitive positioning has not changed, but
clearly the demand environment is weaker than we had expected. We are
lowering our Q2 revenue estimate to $7.8 billion, below the company’s forecast
range of $8.0-8.6 billion, and our earnings estimate goes from $0.14 to $0.10. Our
full-year 2006 earnings estimate has declined from $0.95 to $0.80.
Intel’s strategy: shifting demand to Q3?
For the second quarter, Intel has little to redress its competitive shortcomings
against AMD, and the company appears to have decided to try and limit market
share loss by simply shifting as much demand as possible out to the third quarter.
Certainly the near-term aspect of that strategy appears to be working. Every data
point we’re able to gather suggests that the second quarter is shaping up poorly
for the PC market. That reasoning underpins our reduction in Intel’s secondquarter
estimates.
Fundamentals bottoming; valuation still attractive on lower
estimates
Our stance on the stock continues to be positive, although clearly the near-term
picture has not worked out as we thought. We can’t say that we think Intel’s stock
will do much for the near term given the poor demand environment and the event
risk we’re discussing. On the other hand we note that Intel’s stock has always
tended to track the trajectory of gross margin and earnings growth. Both of those
metrics are bottoming now and should begin to work in Intel’s favor beginning in
Q3. The valuation is attractive enough, even on our lower earnings estimates, to
merit the buy rating in our opinion.
Weak demand prompts us to cut estimates for Q2 and 2006
We think there’s material risk to Intel’s Q2 outlook in light of recent developments,
and we are reducing our estimates for Q2 and the remainder of the year. Our
thesis in terms of the company’s competitive positioning has not changed, but
clearly the demand environment is weaker than we had expected. Our wholeyear
2006 earnings estimate for Intel has declined from $0.95 to $0.80, and our
revenue estimate declines from $36.8 billion to $35.0 billion – the new revenue
estimate represents a 10% YoY decline.
No reason to call for dramatic improvement in 2007, but
cost reduction efforts should help
In large part because we don’t think it’s reasonable to forecast a more dramatic
YoY improvement in revenue for 2007, we’ve cut our revenue forecast for the
year from $42.2 billion to $39.5 billion – the new revenue forecast implies 13%
YoY growth. The resulting cut to earnings drives the EPS estimate from $1.32 to
$1.20. It’s worth noting that we continue to look for significant margin
improvement from Intel next year, and our margin estimates for next year don’t
change much. To the extent that revenue is weaker, we think that the lower cost
absorption should be counterbalanced by Intel’s cost reduction efforts.
Big snapback in 2007 volume embedded in the numbers,
but 2006 shipments for Intel are artificially low
A look at expected unit volume for Intel next year lends additional color.
Following on this year, for which we now expect unit volume to decline
significantly per the table below, we think that Intel can see unit volume growth in
2007 in the mid teens, albeit at the expense of further price declines. The
improvement is less dramatic in terms of real end demand than it appears, being
as a portion of Intel’s 18% unit growth in 2005 wasn’t consumed until the first half
of this year. In end market terms we think that Intel is seeing volume growth in
the 5% to 6% range this year, and the 9% to 10% range in 2007.
Fundamentals should bottom in Q2; stock still attractively
valued on lower estimates
Our stance on the stock continues to be positive, although clearly the near-term
picture has not worked out as we thought. We can’t say that we think Intel’s stock
will do much for the near term given the poor demand environment and the event
risk we’re discussing. On the other hand we note that Intel’s stock has always
tended to track the trajectory of gross margin and earnings growth. Both of those
metrics are bottoming now and should begin to work in Intel’s favor beginning in
Q3. The valuation is attractive enough, even on our lower earnings estimates, to
merit the buy rating in our opinion.
Massive price pressure fits Intel’s short-term strategy
Concerns about Intel’s earnings outlook are nothing new, and although our cuts
are significant we’re not sure that the stock price doesn’t already reflect the lower
expectations. However, we think that there are interesting happenings afoot that
investors need to understand.
We think that Intel has deliberately squashed PC demand in the second quarter
by repeatedly and loudly discussing price cuts. Every PC supply chain player in
the world must know by now that Intel is planning substantial price cuts on July
23, which is the scheduled launch date for Intel’s next-generation Conroe desktop
processor. Our recent checks at the Computex show in Taiwan, which is running
this week, indicate that the cuts are being widely discussed. For the second
quarter, Intel has little to redress its competitive shortcomings against AMD, and
the company appears to have decided to try and limit market share loss by simply
shifting as much demand as possible out to the third quarter.
Certainly the near-term aspect of that strategy appears to be working. Every data
point we’re able to gather, from the very weak April SIA processor data to the
poor results from Taiwanese motherboard makers in May, suggests that the
second quarter is shaping up poorly for the PC market. That reasoning underpins
our reduction in Intel’s second-quarter estimates.
PC OEMs and DRAM distributors seem to expect a better
second half
Whether or not the strategy results in a stronger third quarter for Intel is still hard
to say. On the positive side, we note that DRAM prices have remained
reasonably steady. That would indicate to us that PC OEMs and DRAM
distributors have decided to hang onto inventory despite the poor current
environment. Evidently those players believe that a better demand environment
may be coming. Also to be considered is the price cuts. Not only is Intel getting
ready to slash the price of its existing desktop products by as much as 60%, but
we also believe that the Conroe processors will be introduced at lower price
points than normal for a new Intel product.
That should be attractive for PC
OEMs and buyers alike. It also appears to us that Intel is in the middle of a
channel-cleaning effort – the low processor shipment data and the poor
motherboard results suggest that everyone downstream from Intel is working hard
to bring inventories down. Lower channel inventories would be positive news for
Intel entering Q3.
Watch out for Intel’s inventory and Vista pushout problems
The big potential problem for Intel in Q3 could be inventory on the company’s own
balance sheet. Intel management has repeatedly said that the company prefers
to run its fabs as full as possible, and that creates the potential for ballooning
inventory. If Intel ends up struggling with excess inventory through the third
quarter, the resulting writedowns could negate much of the improvement the
company might otherwise be able to generate. The other potential problem is
simply bad demand – the absence of Vista as a demand driver for the second half
of this year may cause PC OEMs to simply pull in their horns for the remainder of
the year. All in all, we still think it’s reasonable to project a strong improvement
for Intel in Q3 and Q4 off our lower Q2 numbers, and that’s reflected in our
estimates. We do note that the absolute level of revenue for the latter half of the
year is still down from our previous estimates.
Price Objective Basis & Risk
Our price objective of $25 for Intel is above the normalized value of $21 but far
below the stretch-high value of $30 suggested by our return on operating capital
model. We are valuing the stock on 2007 earnings power at this point. Looking
into 2007, we believe that the company has substantially more earnings power
than the street realizes, and we note that on our $1.20 earnings estimate the
price objective represents a 21x earnings multiple, which we regard as
reasonable. The risk factors to our price target and recommendation are slower
demand in the PC business and the possibility of excess manufacturing capacity
problems at Intel, which could cut more pressure on profitability than we have
anticipated.
AI
