INTC’s 1Q12: encouraging signs

the results

After the close of trading on April 17th, INTC reported 1Q11 results that were a bit better than the company had guided to three months earlier.  Revenues came in at $12.9 billion, net income at $2.7 billion and eps at $.56 ($.53 on a non-GAAP basis).  This compares with the Wall Street analysts’ consensus of $.50 and $.58 that the company posted in the year-ago quarter.

Quarter on quarter, results were down, as the company felt the full force of the supply disruptions caused by flooding of hard disk drive factories in Thailand.  Basically, INTC customers couldn’t get hard drives to make all the PCs they wanted.  They also didn’t know when production would return to normal.  So they cancelled orders for new microprocessors from INTC and ran down to the bone the microprocessor inventories they had on hand.

Year on year comparisons aren’t straightforward, either.  1Q11 contained 14 weeks, versus a “normal” quarter of 13, like 1Q12 was.  So the yoy revenue comparison, $12.9 billion in 1Q12 vs. $12.8 billion in 1Q11 is considerably better than it looks.  The biggest yoy difference in expense comes in R&D, where this year’s $2.4 billion is much higher than the $1.9 billion INTC laid out in 1Q11.  Had R&D spending been flat yoy, INTC’s net would also have been flat, and eps up slightly (on a lower share count) yoy.  Not bad for a component-constrained quarter that was one week shorter than 1Q11.

details

I reread my post on INTC’s 4Q11 before starting to write this.  I think you should read it, too.  I haven’t changed my thinking.  And otherwise, I’d just be repeating here what I said there.

Three factors are new, though:

–it looks like the hard disk drive shortage is over already, a couple of months earlier than INTC had initially thought.  The company expects 2Q12 sales to be in line with final demand, with inventory restocking by customers only happening in the second half.  My guess is the net result will be a slight uptick (maybe $.05) in full-year eps from my prior guess of $2.75 for 1012, rather than just a reshuffling of the quarters. (Remember, this includes $.15 a share that Thai flooding shifted out of 2011 and into this year.)

–INTC has dropped its tax rate guidance from 29% to 28%, which I take to mean the company is lowering its expectations for the US and raising them for emerging markets.

–INTC is starting to churn out 22nm chips in volume.  At the same time, TSMC is reported to be having trouble with its 28nm manufacturing process.  This should help extend INTC’s performance lead–or close its performance gap–versus competitors who use foundries (meaning just about everyone).

where to from here?

As I wrote three (and six) months ago, at $20 a share I think INTC was a buy simply on the notion that the company wouldn’t fade away within the next two or three years.

At close to $30, the decision is different.  I think you have to believe a lot more–at the very least, that ultrabooks will be a big success.  It would be better, of course, if INTC could make some inroads into ARMH’s franchise in tablets and smartphones, as well.  In both areas, signs are encouraging.

–There are already almost two dozen ultrabook models on the market, with another hundred or so on the way before yearend.  Some will be configured to use the touch features of Windows 8; some will be hybrid devices that can function as tablets as well as traditional PCs. Better still, to my mind, is the fact that ultrabooks are coming from Samsung, Asus and Acer–meaning they’ll be stylish and more reliable than, say, Dell.

Ultrabooks have also gotten a very favorable mention in computer guru (and Mac aficionado) Walter Mossberg’s Spring laptop buyers’ guide in the Wall Street Journal. 

–Rather than waiting for customers to come knocking at its door, INTC created a “reference design”–a detailed blueprint–for the ultrabook and presented it to computer manufacturers.  It’s taking a similar tack with cellphones.  It’s offering its reference smartphone design to carriers to use as their “house brand.”  It’s already signing up customers.

Who knows where this will lead?  But the fact that most carriers are selling iPhones to customers at $400 below their cost should be a powerful motivator to look for cheaper alternatives.

cascades of economic energy and finding a stock-picking focus

finding the focus

One of the most creative (and successful) investors I’ve ever encountered–and, luckily for me, one of my earliest mentors–gave me this example of his investment style:

Suppose, he said, Washington has decided to stimulate the economy and we’re in the early days of a nationwide road building boom.  What stocks do you buy?

–Your first inclination is to look at construction companies.  That’s what most people buy.  But they’re usually conglomerates, with significant non-public works subsidiaries. There are also lots of them.   It’s difficult to predict who will get contracts and how profitable they will be.

–Your next thought is probably construction materials, like cement or asphalt.  Certainly, roadbuilding will require lots of that stuff.  But the same problem arises here, on a smaller scale–determining who, among many possible suppliers, gets the contracts and how important they are for the overall profits.  One extra quirk:  the low value-added nature of construction materials and their high weight (meaning big transportation costs) make individual plant locations crucial.  Figuring that out is especially hard.

My friend’s answer?  …cement trucks.  Buy stock in the one or two companies whose main business is making cement trucks.  No matter who gets the government construction contracts, no matter which suppliers they choose, they’ll need to transport cement to the construction sites.  As orders build, they’ll have to upgrade their truck fleets.  Large-scale contracts also mean large-scale upgrades.  That’s where the economic energy from the government road building program is going to be focused.

cascades of energy…

This is absolutely right, in my opinion.  It’s Levy Strauss selling blue jeans to Gold Rush miners all over again.

To recap, the surest and safest way to play any economic phenomenon is to find, if you can:

–the sole supplier

–of an essential component

–whose price makes up a very small cost in the creation of the ultimate end product made or sold.

This most likely means that buyers of the component will be much more concerned with the quality of the component than the price.  So the component maker should be able to make unusually high profits.

In my experience, I’ve found there’s also another–time-related– aspect to investor behavior in playing any powerful source of economic energy.

Institutional investors typically proceed as follows:

–initially they tend to buy largest-cap and most obvious ways to play whatever the theme is.  In the context of my friend’s road example above, they buy the general construction companies.

–after the prices of these stocks have gone up for a while, the big investors’ attention begins to move to the most obvious derivative plays–the cement companies–and buy them.

–ultimately they “discover” the cement truck companies and add them to their portfolios as well.

If you know the industries involved well enough, you can see a cascade of successive waves of investment that chronicles the travels of the consensus deeper and deeper into the derivative plays.

…forming a timeline

This changing, and ever narrowing, focus of big investors typically forms a timeline that we can use to judge how much energy remains in a given economic phenomenon in stock market terms.  Once the big guys work their way to the metaphorical cement trucks, that signals most of the money from the theme has already been made.

At this point, the market either goes back to the start of all the excitement–the general construction companies–and begins the cascade process all over again.  More commonly, the market moves on to other areas.

where are we now?

Although it’s relatively early in the 1Q12 earnings season, I’m struck by two characteristics of the market reaction to earnings announcements so far.

The first is that positive reaction is highly company-specific and relatively narrowly focused in the sense I’ve been writing about.  To me, this means that before long the market will no longer be following ever more indirect ways to play the fact of economic recovery from the Great Recession.  It will be looking for new areas of interest instead.

I’ve also noticed that my portfolio, which is more of the cement truck type–and which had been in the dumps for the past several months–is beginning to perk up again.  Yes, my stocks have had an extraordinary two years or so before starting to fade away, but that’s the past and not relevant for today.  I’m also reading my recent outperformance as evidence of an ongoing maturing–maybe even an upcoming sea change–in stock market focus.   More about this in my next Current Market Tactics, on Monday.

 

chit funds, crowdfunding and p2p banking (II)

two lessons from history

Thailand

I was just getting acquainted with Thailand when the Ms. Chamoy Thipyaso chit fund scandal broke.  “Mae” (=Mother) Chamoy, the wife of a Thai Air Force officer, appeared to be running a very large chit fund investment operation that was stringing together a sequence of startlingly high investment returns.  She had agents throughout Thailand collecting new money for her.  Money was pouring in.

The fund turned out to be a gigantic Ponzi scheme, however.

The scheme sustained itself for an unusually long time.  It continued to operate even after it had become so large (US$100 million+) it was implausible to think Mae could find enough lucrative “secret” microfinancing opportunities in Thailand.  Several reasons for this:

–people wanted to believe.

–the fund appeared to have the backing of the military, the ultimate source of political and business leadership in Thailand.  This gave an implied assurance that the investment results were real.  Prominent high-ranking Air Force officers invested with Mae, and forcefully urged their subordinates to do so as well.

–investors who thought about withdrawing some of their “profits” were pressured not to do so, with the threat that if they took money out they would be blacklisted and not allowed to invest in the fund thereafter.

Interestingly, large investors in the Chamoy fund continued to urge their friends and work subordinates to plow money into the fund even after they realized it was a Ponzi scheme.  Their rationale?   …it bought them more time.  That extra time allowed them to continue to enjoy a lifestyle they knew was going to end when the fraud was discovered.  And it allowed them to arrange their financial affairs in a way that would minimize the negative impact on them personally.  To followers of the Bernie Madoff case in the US, this must certainly sound familiar.

my thoughts

In my reading about microfinance, it seems that Ponzi schemes have been a constant problem wherever third-party chit funds–not the ones where friends and neighbors lend to one another–operate.  That means virtually everyplace in South Asia and Africa.  There seems to be an especially large amount of study done of the industry in India, which I have no practical experience with (because the stock market isn’t easily open to foreigners–and I think the political environment is particularly unfriendly toward equity investors.)

Personally, I’d worry more about Ponzi schemes in the US springing up among the firms that the JOBS Act will allow to raise equity.  These are the entities that won’t have adequate financial controls or accounting statements for shareholders.

My chief p2p banking concern is a more prosaic one–that the present very low loan loss rates will prove to be more a function of the industry’s newness rather than of the creditworthiness of borrowers.  Time will tell.  And, unlike fraud, this is a risk we can take precautions for.

Taiwan

There was a unique twist to the Taiwanese chit fund industry that I encountered in the mid-1980s.   Chit fund loans were secured by post-dated checks issued to the borrowers by the lenders.  In Taiwan at that time, “bouncing” a check–having insufficient funds in the account to cover payment–was a felony, punishable by the check writer serving time in prison.

The threat of jail time was thought to be sufficient incentive to ensure repayment.  So no one worried too much about the creditworthiness of the borrowers, which–as it turned out–included large publicly-traded companies.  American accountants I met, who’d been sent to Taiwan to break into the auditing business there, told me that they could see the fact of unaccounted-for money sloshing around in potential client companies.  They just couldn’t see how much.  Because of this, they were reluctant to take any engagements.  And they were continually undercut by local accounting firms who charged virtually nothing for “audits.”   American bank lending officers told me the same thing.

The chit fund business received a major shock, during a mild economic downturn, some large companies had made hundreds of millions of dollars in chit fund loans–all unrecorded in the financial accounts–that they couldn’t repay.  Bankruptcies resulted.

my thoughts

This is another potential problem for equity holders in firms crowdfunded under the JOBS Act.  Without audited financials, it’s impossible for an outside investor to determine what the capital structure of a company is.

I also think, à la Taiwan, a legitimate auditor will simply walk away from a suspect company rather than make a public outcry.  Non-disclosure agreements may force it to do no more.  A less fastidious auditor, one nobody ever heard of, might take the business and issue a clean opinion.  After all, Bernie Madoff got one for years, didn’t he?

chit funds, crowdfunding and p2p banking (I)

chit funds in emerging markets

I began to look at smaller Asian markets as an investor in 1985.  It was there that I encountered the informal self-help savings and lending associations that are typical in developing economies.  My introduction came through chit funds in Thailand and Taiwan, but these structures exist throughout the developing world.

what they are

the simplest

In their simplest form, the associations are groups of friends of neighbors who contribute a specified amount of money to a pool on a regular basis.  The funds pooled each time the group meet are lent to a single participant, determined either by the implied interest rate bid or on a rotating basis.

more complex

At a higher level of organization, groups come to a designated place at a specific time–like by having a meal at a certain restaurant on Saturday–and offer to third parties the money they’re willing to lend.  They may signal their intent simply by piling their money in the center of their table.  Prospective borrowers move from table to table to negotiate loan terms.

the pinnacle

For the largest such chit funds, agents for the fund do the collection and forward the money to the fund’s central headquarters.  Lenders don’t have any direct contact with the borrowers.

why chit funds?

There are a number of motivations, normally all based on the idea that the formal banking system doesn’t function well. For instance:

1.  There may not be any local banks.

2.  Banks may offer very low interest rates to depositors.

3.  Banks may decide to lend only to large companies.

4.  Potential depositors may worry about bank solvency–the possibility that they’ll lose their money in a bankruptcy or nationalization.

5.  People may not want to reveal the extent of their wealth, or the extent of their taxable income.

the US equivalent

Interestingly enough, this emerging world form of microfinancing is beginning to make a strong showing in the US.  It’s taking two forms:

–Congress recently passed the JOBS (Jumpstart Our Business) Act.  JOBS greatly simplifies the procedures for a small company to make an offering of equity.  For companies with less that $1 billion in annual sales, JOBS does away with the requirement that they present audited financials to potential investors (not a stellar idea, in my opinion).  JOBS also defines the maximum amount that low-income investors can put into a given offering.  By so doing, it legitimizes the efforts at equity crowdfunding (see my post) now underway in the US.

–John Mack, former head of Morgan Stanley, recently joined the Lending Club, a P2P (peer to peer) lender.  P2P lending is chit funds come back to life, but on the internet instead of in your local restaurant.  You can go to the websites of P2P firms like Prosper and Lending Club and select the borrowers you wish to lend to by yourself.  Or you can hire a financial advisor to do this for you.

why now?

To start with the obvious, the technology needed to run P2P or equity crowdfunding is readily available.

Interest rates have been low for a long enough period of time–with little relief in sight–that more conventional means for savers to obtain high returns have been exhausted.  Not only that, but getting a return above 2% in Treasury bonds requires committing money for a very long time, exposing the lender to the risk of loss as/when rates eventually begin to rise.

I see the JOBS ACT as an attack (maybe as the first step in a prolonged attack) by Washington on the current IPO practices of Wall Street investment banks.  Conventional IPO costs in the US are very high by world standards, and a private individual stands about the same chance of getting an IPO allocation as a snowball in northern hemisphere July.

The naming of the JOBS Act suggests that Washington wants to be seen as doing something to create jobs.  What a commentary if this is the best they can do.

My first reaction to P2P is that it may be a true innovation, like money market funds and junk bonds were in their day.  P2P could end up being a very big business–unlike JOBS, which I see, in its present form, as gimmicky and filled with opportunities for fraud.

That’s it for today.  Tomorrow:  historic problems with P2P lending, including a word on Bernie Madoff.