a closer look at Intel’s 2Q14

2Q14 results

After the close of Tuesday, Intel (INTC) reported a strong 2Q14.   Revenue came in slightly higher than the company’s upwardly revised guidance from last month.  Earnings per share were $.55 vs. Wall Street analysts’ expectations of $.52 (expectations which were revised upward when INTC announced in mid-June that business was looking up).

INTC also revised up its full-year revenue guidance from basically flat year-on-year to +5% growth.  It said that its server business ($3.5 billion of the company’s $13.8 billion total during the quarter) continues to boom, with both unit volumes and unit prices rising.  That’s no surprise.  In addition, however, the PC business ($8.7 billion in 2Q14 sales) appears to have bottomed and to be bouncing back a bit.

The PC development has two aspects.  Corporate customers, who make up about 40% of the PC total, are buying again.  The simplest explanation for this is that their existing laptops and desktops have just gotten too old.  Buying may also be spurred by the fact the Microsoft is ending support for Windows XP, that corporations don’t regard tablets as a viable substitute for laptops, or simply that firms are flush with cash.  In any event, corporates are buying, and will easily continue to do so in increasing amounts into next year.

Consumers, 60% of the total PC market, may also be showing signs of life–although this is more OEM and distributor body language than actual orders.

Remember, too, that INTC’s sales are not to end users.  So it stands to benefit not only from increased final sales but also by manufacturer and distributors purchases to built up bare-bones inventories.

operating leverage

INTC has substantial operating leverage, both from the capital-intensive nature of its manufacturing and its very large R&D and SG&A budgets.  As a result, small changes in revenue can make a disproportionately large impact on the bottom line (in fact, they’re almost pure profit).  At the moment, the revenue changes in INTC’s two main businesses, PCs and servers, are both positive.

tax rate

INTC is saying it  expects its tax rate to remain at 28% for the rest of the year, implying that the growth it is seeing is mostly coming from the developed world, where tax levies are relatively high.

lines of business

As is always the case in securities analysis, the line of business table is where the real work is done.  For INTC, I’ve duplicated the relevant 2Q14 lines below:

PC Client Group :    revs = $8.667 billion, op income = $3.734 billion

Data Center Group :   revenues = $3.709 billion, op income = $1.807 billion

Mobile and Communications Group : revenues = $51 million, op income = ($1.154 billion).

No, that’s not a mistake.  INTC’s tablet and smartphone chip business had revenues of $51 million for the quarter …and an operating loss of $1.2 billion.

INTC is earning operating income of $22 billion – $25 billion a year from its traditional businesses and using a chunk of that to fund the massive losses it is incurring in trying to break into the mobile computing business.

The M&C Group figures need some interpretation.  The revenue figures are net of marketing or other incentives INTC gives to buyers of its mobile chips; the operating loss includes R&D and other expenditures that arguably have an enduring value.

Nevertheless, the line of business table does convey the essence of the INTC story for shareholders wiling to pay $30+ for a share of stock.  INTC is, in effect, two companies:

–one is a mature microprocessor maker earning $2.50 or so a share and growing at maybe +10% a year

–the other is a startup currently bleeding red ink at a $4 billion annual rate.

my take

The fact that INTC is incurring large near-term losses on its M&C Group says two things to me:

–it doesn’t yet have a set of products customers are willing to actually pay for, and

–INTC believes M&C is crucial to its long-term success.

I might be persuaded to pay 15x earnings for the traditional business, if I thought it would have stable-to-rising earnings.  That would mean a target price in the high $30 range.  However, INTC’s actions imply that top management doesn’t believe the business is viable without M&C.  So maybe the right price for the traditional business would be $30.

That leaves the question of the status of M&C still up in the air, though.

On the other hand, if INTC can create a profitable mobile business, that would mean–to pluck numbers out of the air–total INTC near-term earnings could be $3 a share, with a higher growth rate.  Worth $45 a share?  …probably so.

My bottom line:  news of a cyclical upturn in the PC and server businesses probably supports INTC shares for the time being.  Eventual downside to the high $20s (?) if/as it becomes clear the mobile chip business has no hope.  Upside to $40+ on signs that INTC is narrowing its M&C operating losses.

I find it hard to assign probabilities to either outcome.  For the time being I’m content to remain a holder of the stock.










Intel’s good 2Q14–and Wall Street’s strong reaction to it

Last month, Intel (INTC) announced to the market that its 2Q14 was shaping up better than the guidance it had given when it announced 1Q14 earnings.  Analysts covering INTC (a pretty pedestrian lot, in my view) dutifully raised their estimates to incorporate this news.  The new consensus was centered around $.52 a share in eps for the quarter.  The stock began a 15% move higher.

A week or so ago, research firms that follow the PC industry began to suggest that the personal computer market is beginning to bottom out after a long slide.  At the same time, these firms observed that the tablet market is starting to fall off.  Some put the two observations together into a story that the tablet market was waning because customers were either finding them inherently unsatisfactory or poor value in comparison with chrome- or ultrabooks.  AAPL appeared to confirm this analysis with its announcement of a partnership with IBM to sell iPads equipped with IBM software to corporations. 

INTC reported earnings of $.55 a share after the close on Tuesday (a full analysis in tomorrow’s post).  The company also raised its revenue guidance for full-year 2014 from flat to up 5% (corporate strength, the hope that consumer demand will rebound, plus the one-time positive of wholesalers beefing up their inventories a bit).  My take:  good news–not earthshattering, but good–and pretty much in line with data that had been coming into the market over the past while.

But no.  

Yesterday INTC was up by 9%+ on quadruple normal volume, in a flat market.  MSFT, the other member of the once-dominant “Wintel alliance,” gained almost 4% on more than double normal volume.

As a holder of INTC and MSFT, I’m happy to have the gain.  But I find the market action a bit excessive.  

I have two reactions:

–it may be that part of the rise has nothing much to do with Wintel but is the market rotating toward large-cap tech laggards.  If so, it would be a sign that the upward market momentum of the past nine months or so is in its final stages.

–for INTC, the “free lunch” stage is over.  On earnings of, say, $2.10 in 2014 and $2.25 in 2015 (figures that are higher than Wall Street’s current median, though admittedly some analysts may not have published post-earnings call adjustments), INTC is no longer stunningly cheap.  To continue to hold the stock, we have to believe that the PC business is at least stable and that INTC’s foray into tablet/smartphone chips will at least get to breakeven within a couple of years.

While I may trim my position further (as I’m writing this, I haven’t yet), I like what INTC is doing and am content to remain a holder.

More tomorrow.