the INTC announcement

Yesterday, INTC issued a press release and conducted a brief conference call to say that earnings per share for 4Q11 were going to be lower than anticipated. The stock fell about 4%, in a weak market, on the news.

The reason?

Recent flooding in Thailand (see my post) has put most of that country’s hard disk drive manufacturing capacity–about 40% of the world’s HDDs are made there–out of commission.  Production won’t be back to normal until May or June.  INTC’s original supposition that inventories of HDDs in the supply chain would be enough to tide makers of PCs and servers over has proved to be too optimistic.

About two weeks ago, HDD makers began to tell device makers how many HDDs and of what type they would be able to deliver in 1Q12.  The numbers are low.  Device makers immediately cancelled orders for large numbers of chips they’d planned to buy from INTC, since there’s no sense in buying components that will be gathering dust in a warehouse waiting for HDDs so a PC can be assembled and shipped.   Hence the public announcement of lower 4Q11 results.

1Q12 eps will doubtless also be less than Wall Street had been expecting, although INTC had not given formal guidance.

eps for 4Q11…

The press release was very brief.  Previously, INTC had expected revenue of around $14.7 billion for 4Q11.  Due to order cancellations, the company now thinks revenue will be closer to $13.7 billion.  Margins will be relatively unaffected.  Yes, volumes will be lower, but device manufacturers are putting the HDDs they are allocated into their highest-profit products (duh!)–which typically also contain INTC’s highest-margin chips.

Analysts had been figuring that INTC would earn $.69 per share for 4Q11.  I think the actual outcome will be around $.63.

 

Looking at the figures another way, INTC was selling chips at a rate of $1.13 billion a week before the industry became aware how low 1Q12 production of HDDs would be.  Subsequent cancellations amount to a bit less than one week of INTC’s December production, or about a quarter of its monthly output.

…and 1Q12

This is anyone’s guess.  Everything depends on how quickly HDD output in Thailand can be restored and on whether it comes back in a linear fashion or in big lumps.  It’s possible, for example, that INTC will be selling at 75% of a normal rate for most of the quarter and then have a huge number of chips fly out the door during the last two weeks.

My stab in the dark is that earnings per share for the quarter could be as low as $.50 but will probably be higher.

more important, earnings will be deferred–not lost

INTC said repeatedly during its conference call (analysts kept asking the question, over and over) that the revenue decline it is experiencing is due solely to lack of HDDs from Thailand.  Its monitoring of sell-through of PCs and servers indicates that end-user demand remains strong and is growing in line with INTCs expectations.  True, Europe may be a little weaker than INTC thought, but Asia is better.

Servers are unaffected.  Device makers are simply not producing the lowest-priced PCs.

Once HDDs are again available, INTC expects the market to return to normal.  Device makers will doubtless boost purchases from INTC to restore the inventory levels they are now running down.

impact on INTC’s production

INTC isn’t going to slow production down, even though my guess is that about 25% of what it is making will, in one form or another, remain in inventory for a while.  Several reasons:

–it can take months to make semiconductors, so INTC can’t just turn production on and off

–INTC is just beginning to ramp up production of its next generation 22 nanometer chips, so it doesn’t want to slow down on them

–the company believes (correctly, in my opinion) that there will be a pickup during late 1Q12 or early 2Q12 that’s just as rapid as the current slowdown.  It would be crazy to miss that sales opportunity just to save a penny or two in eps now.

what about solid state drives?

…the ones made from flash memory.  So far, INTC sees no move by PC makers to substitute more expensive SSDs for HDDs.  INTC, however, believes the future of laptops is in Ultrabooks, sleek Macbook Air-like devices.  So it’s going to see what it can do to use the shortage of HDDs to push device makers to transition more quickly to SSDs.

the stock

INTC shares lost 4% yesterday, in a market that was down 1.5%.  I interpret this as meaning Wall Street is going to ignore the current eps weakness and focus instead on INTC’s low valuation, high dividend and reasonable prospects for growth.  I think that’s the right thing to do.  (A purist might argue that a deferral of, say, $.20 in eps for six months is really a loss of at most a penny, so that the $1 a share fall in the INTC stock price is excessive.  But you’ve also got to factor in something for the uncertainty of the situation and the fact that the market as a whole was down.)

I still think the stock is cheap.  There may be a better buying opportunity when the market gets around to thinking about 1Q12 earnings, or if the current period of market weakness continues into next year–which it could.  On the other hand, there may not be.  I own a lot of INTC, so I’m not tempted to buy.  If I owned none I might be.