Intel’s 3Q2010 earnings: about as expected

the results

INTC reported September quarter 2010 earnings after the market closed on Tuesday.  Revenue was a company record at $11.1 billion.  Operating income for the three months was $4.1 billion and net was $3.1 billion or $.52 per share. That last number was $.01 above the Wall Street consensus.  Figures also exceeded the company’s previous best result, in the June 2010 quarter, by about 3%.

guidance lowered in August

If you recall, on August 27 INTC lowered its 3Q guidance–initially offered on July 13th, when it announced June quarter results.   It said revenue would be around $11 billion, down from around $11.6 billion.  It also said its gross profit (meaning after deducting manufacturing expenses) would be 66% of sales rather than 67%.

Why?  …because sales of computers to consumers in the mature markets of the US and Western Europe were proving unexpectedly weak.  A 5% fall in INTC’s overall revenue estimate implied that such sales would end up 20%-25% worse than INTC–and its computer manufacturing customers–had thought.


The 2.8% quarter on quarter sales growth that INTC ultimately achieved, while a quarterly record, fell significantly below the normal seasonal quarter on quarter increase of 9%.

Other than the consumer in the US and Europe, all other areas of the company’s business were very strong.  The company said that the fact that 3Q sales ended up $100 million stronger than its base case should be interpreted as indicating some improvement of the consumer PC business in September.

INTC’s tax rate was 1.5% lower than the company had anticipated, implying that a large amount of the softness in demand occurred in high tax rate areas, presumably the US.


INTC is guiding to sales of $11.4 billion, +/- $400 million for 4Q2010.  This would be another record, but below the normal seasonal bounce of +8%.  Consumer weakness in mature markets is again part of the reason.  In addition, demand for INTC’s newest generation of chips, named Sandy Ridge and scheduled to be launched in 1Q2011, has been “much” better than anticipated.  Customers will try to run down their existing inventories of older chips as much as they can so they can offer Sandy Ridge chips as soon as possible in the new year.  This means purchases will be below normal this quarter.

The company believes worldwide microprocessor demand will be up by 15% or so in 2011.  Several reasons:

–strong growth from emerging markets,

–continuing rolling replacement of older corporate computers and servers,

–stabilization, and maybe pickup, in demand from consumers in mature markets

(Implied but not stated is that INTC will retain its dominant market share.)

cannibalization by the iPad?

INTC’s answer:  not so far.  It’s reasoning (filled in a little by me) is straightforward.  Worldwide, third quarter PC shipments were around 90 million.  They fell by about 5% below expectations.  Therefore, expectations were for shipments of about 95 million.  The difference is about 5 million, the shortfall being entirely in the US and Europe and mostly in low-end laptops and desktops–many for back-to-school.

AAPL probably sold 5 million iPads during the quarter.  (Here’s where I start making stuff up.)  Suppose 1 million of them were sold outside the US and Europe, leaving 4 million.  For iPad cannibalization to have been a more important factor than overall economic weakness, you’d have to believe that at least half the buyers of iPads during the quarter started out to get netbooks or low-end laptops they were going to use for high school or college but ended up with iPads instead.  I find it hard to believe that cannibalization could be so widespread so soon, especially since many buyers would be trading up in price.

Also, the demographics may not overlap between PC and iPad users.

Yahoo, admittedly not a young person’s site, has published the most detailed demographics I can find about iPad owners.  Relative to other Yahoo users, people accessing from iPads tend to be more heavily concentrated in ages 30-54.  US users are roughly 50% male, 50% female (as opposed to American colleges, which skew heavily female).

Nielsen also recently released a study of 5,000 US connected device users, of whom 500 were iPad users.  The research firm characterizes the iPod respondents as young, male and very receptive to advertising.  Look at the chart Neilsen supplies, however.  It’s true that iPad users skew far younger than iPhone users, 83% of whom are over the age of 24.  But 64% of iPad users are over 24 as well.  Neither represents the back to school crowd.

How do respondents use their iPads?  They listen to music and read news, just as they do on their smartphones, but they also look at movies and TV shows and read books and magazines.  No one uses the iPad as a content creation device, to research and write term papers for classes.

my thoughts

INTC will likely earn about $2 a share for 2010.  If you believe the company forecast for semiconductor devices in 2011 and assume INTC will retain its current market share, then it will likely earn about $2.40 a share next year.  The stock now yields about 3.3%.  If the company were to raise the payout in line with earnings expectations implied by a 15% revenue increase, it would have a prospective yield higher than a 30-year Treasury bond’s.

Why, then, is the stock trading at under 10x current earnings?  It’s because the median analyst estimate for INTC for 2011 and 2012 is (slightly) under $2 a share.  The numbers say Wall Street thinks the company’s profits are at a cyclical–and maybe secular–peak now.

Actually, I think analyst opinion is more negative than that but that researchers are unwilling to voice their bearish thoughts in print.  Here’s why.

If we consider INTC’s processors as dollar-denominated commodities, then the slide in the US$ over the past several months should be beneficial.  Emerging markets’ demand will likely continue to be strong.  The company’s cloud computing and imbedded chip lines are booming.  Corporations will likely keep on slowly and methodically replacing their oldest servers and PCs.

Based on a stable to strengthening world economy next year, it would be hard not to pencil in around 10% eps growth from these business areas alone.  I think the reason analysts aren’t doing so is that they fear that the current weakness in consumer PCs is just the tip of the iceberg.  They may quibble with a 15% growth assessment, but their real concern is that we are on the doorstep of a change from the Windows/Intel axis that has ruled the PC world for decades to a new Apple/Arm or Android/Arm one where INTC is not yet able to compete.  They are tacitly forecasting a decline in the INTC consumer business next year.  They’re just keeping the magnitude small enough that the change in direction isn’t apparent.

A potential investor in this stock on any basis other than the dividend has to have a satisfactory answer to two questions, I think.  The first is whether there’s enough evidence to conclude we’ve reached a tipping point in the consumer PC business where the market is changing in such a way that INTC can’t compete effectively any more.  The second is, if so, how bad can things get and how much of that is already baked into the INTC stock price.

I’m a growth stock investor, so answering questions like this is not what I do (or, at least, not well enough to earn a living at).  My instinctive reaction is that we don’t know enough yet to say the consumer is lost to INTC, and that, in particular, we haven’t yet seen a competitive response to the iPad from INTC’s customers.  One might think that at under 10x earnings, quite a lot is already discounted, but the crucial issue is whether in bearish circumstances what is the minimum that INTC is likely to earn.  The $2 figure that analysts are putting forward is probably the least helpful number, since I think it’s the least likely to be correct.  INTC will either earn significantly more or much less, depending on how it fares with the European and US consumer.

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