We expect few surprises when Intel Corp (INTC) reports earnings later this week, as reflected in the limited number of estimate revisions over the past few months.
Third Quarter Highlights
Intel Corp’s third quarter earnings were slightly better than the company’s expectations, exceeding the Zacks Consensus by a couple of cents. Revenue was also more or less in line, helped by stronger demand from China and other emerging markets. However, management had lowered guidance significantly prior to the earnings announcement, so investor reaction was muted.
Intel had misread the softness in the consumer computing market in North America. A couple of analysts had pointed out that the inventory accumulation in the channel had become apparent only after Intel reported (it is one of the companies that usher in the earnings season). Therefore, Intel’s guidance could not have taken it into account. That said, the enterprise business remained steady, enabling Intel to generate solid cash flows in the neighborhood of $3.5 billion.
Fourth Quarter Guidance
Fourth quarter revenue guidance was conservative, although gross margin guidance was very encouraging, despite expectations that pricing would cease to be a driving factor and some startup costs related to 32nm manufacturing would impact it. Inventory adjustments were cited as the main reason for the expected gross margin expansion. Applying the flattish opex and 31% tax rate, we get expected earnings of 54 cents per share, a penny shy of the Zacks Consensus Estimate for the quarter.
Agreement of Analysts
Analysts expressed concern regarding Intel’s performance in the fourth quarter, given the inventory accumulation and cannibalization by the iPad. However, just one of the 40 analysts providing estimates for the quarter made a downward revision. Again, this was the only analyst out of a total of 43 that lowered estimates for the year.
However, 2011 is a slightly different story. Analysts, by and large expect Intel’s business to be negatively impacted by growing demand for tablets, since Intel is not likely to set foot in this market until the second half of 2011. This according to many was too big a delay, with the real possibility of hindering Intel’s growth. Analysts were also concerned about the effectiveness of Intel’s Atom family and expressed skepticism regarding its ability to make itself felt in the mobile computing space. Of course none of the analysts were concerned about Intel’s ability to maintain position in the enterprise segment and all were equally excited about Sandy Bridge. The net result was that 2 of the 37 analysts providing estimates for the March quarter raised estimates. They also raised estimates for the year. However, 1 analyst lowered estimates for 2011 during the past week.
Magnitude of Revisions
As may be expected, the Zacks Consensus Estimate for the next two quarters and years has not moved in the last 30 days, although the last 60 days saw the estimate for the March quarter moving up a penny, with that for 2011 moving up a couple of cents. The Zacks Consensus Estimates for the next two quarters and for 2010 and 2011 have increased 3 cents, 2 cents, 5 cents and 5 cents, respectively, over the last 90 days (since the company last reported).
Intel remains the leader in the enterprise segment and we believe that investors are not paying enough attention to the company’s continued success in the server segment. As one analyst mentioned, the low-power devices that are currently selling like hot cakes will be more dependent than ever on strong server chips. Additionally, data centers are upgrading and Intel’s powerful devices are the obvious choice. Additionally, with its tick-tock strategy, we believe that it is way ahead of the competition in terms of technology. So Intel’s supremacy in servers is likely to be sustained.
The next segment to consider are corporate buyers that are steadily replacing PC fleets. Given Microsoft Corp’s (MSFT) Windows 7 and Intel’s new processor families, the Wintel domination here is likely to remain. Of course, there has been some news flow about Apple Inc (AAPL) making inroads, but we believe Apple belongs in the consumer segment for two reasons – first, Apple PCs run on ARM Holdings (ARMH) chips that would not be able to hold a candle to Intel devices that are built for power. Second, while some corporate spending may be diverted to mobile devices for employees, it is unlikely that core computing preferences will shift. Note that Intel’s newer chips are also more energy efficient.
Investors are however focused on the much-hyped consumer segment, inasmuch as the novelty of the devices tends to distract them. As a result, they are more than a little concerned about Intel’s prospects here. Intel, with its McAfee and Infineon asset acquisitions has also confused them. We are actually unable to tell what Intel intends to do with them. But whatever it is will be interesting to watch.
We remain positive about Intel and believe in its prospects, but we have a Neutral recommendation on the shares, as we believe that investors will continue to discount them. Intel also carries a Zacks Rank of #3, implying a short term Hold recommendation.