RealMoney Silver - Intel Has Its Ducks in a Row

Intel Has Its Ducks in a Row
By Bill Trent
RealMoney.com Contributor
10/10/2007 2:19 PM EDT

Intel Corp. (INTC) is scheduled to report earnings Tuesday, Oct. 16. The consensus among sell-side analysts is that the company will report sales of $9.6 billion (up 10% year over year) and earnings per share of 30 cents. This puts the average analyst daringly close to the precise midpoint of the guidance Intel provided as its midquarter update.

According to the Semiconductor Industry Association, the year-over-year sales growth for the industry has ranged from 1.7% to 4.8% over the last six months. For the largest manufacturer to be growing at more than twice the overall industry rate seems somewhat aggressive at first glance.

However, the nadir in industry sales was in June, and the growth rate has been picking up steadily since then. Furthermore, the industry as a whole has been more disciplined about adding capacity.

After more than a year of ordering more chip-producing equipment than was needed to satisfy demand from customers, the past six months have seen orders for new equipment being placed at a far slower rate. In fact, sales of semiconductors in August grew 4.8%, while orders for new equipment saw a 19.4% decline year over year.

Since pricing is determined by supply and demand, when demand is growing at a faster rate than supply, it should be good for pricing, margins and the stocks, subject to a lag between the time equipment is ordered and when it is installed.

Last month, when the PPI data showed a poor pricing environment for semiconductors (see the chart of year-over-year price changes below), I said, "I happen to believe the worst will soon be over for semiconductors."

The reason for my belief is that this year's poor pricing environment stemmed from last year's over-ordering of equipment, so this year's thriftiness should start to improve pricing sometime soon.

Year-Over-Year Pricing for Semiconductors

Source: Bureau of Labor Statistics

Furthermore, since Intel and rival Advanced Micro Devices (AMD) were the first companies to over-order, the first to see the damage it did to their margins, and the first to announce cuts to planned expenditures, it should surprise nobody if they are the first to recover as well.

Addressing the issue of whether the guidance is too aggressive, a look at the historical data suggests otherwise. Margins for both AMD and Intel are lower than they have been at any time since the depths of the technology bust. A modest improvement from current levels would still leave them well below the normal range, if there is such a thing.

Source: Zack's Research Wizard

Finally, I looked at inventory levels to see how supply and demand were trending at the company level. For Intel, at least, the inventory levels appear to be drifting back toward normal.

Source: Zack's Research Wizard

Stock performance after the report may come down to the December quarter guidance relative to expectations. There, too, however, the consensus appears beatable.

Current estimates call for $10.4 billion in sales, which is just a 7.5% year-over-year rise. Given the acceleration in industry growth, that rate may be in line with the overall industry rate, even though Intel may be leading the group up.

Because company inventory levels have peaked, margins have potentially made a bottom and overall industry health looks likely to improve, I believe Intel's guidance is not aggressive, and may even be conservative.