Air Getting Thin for Intel Shares

Despite shedding more than half its value over the past two years,

Intel

(INTC) - Get Report

continues to trade at a level that even the most bullish analysts say is high. The chip giant's first-quarter earnings release Tuesday could serve to underline that point.

"It is expensive relative to its growth rate," said Joe Osha, an analyst at Merrill Lynch who has a near-term strong buy rating on the stock. "It's something investors should be concerned about over the long term."

Intel, which trades at 45 times this year's earnings and 28 times 2003 estimates, has a long-term growth rate of just 7% to 8%, according to Osha.

But it's not just the long term that investors need to be worried about. Intel's first-quarter earnings are likely to hit the mark on Tuesday, but most analysts say the company could very well guide down its revenue projections for the second quarter by more than the usual amount.

Arithmetic Logic Unit

Intel is expected to report earnings of 15 cents a share for the first quarter, compared with 16 cents a year earlier, on revenue of $6.79 billion. Analysts currently expect a profit of 68 cents for the year.

In its midquarter update in early March, Intel said the quarter and year were progressing "according to our expectations" but that there were still no signs of a recovery in the business.

The firm projected first-quarter sales of $6.6 billion to $6.9 billion, compared with a previous range of $6.4 billion to $7 billion.

"That's pretty late in the quarter to be giving an update," said Thomas Thornhill, an analyst at UBS Warburg. "The chances of a material change in the remainder of the quarter are relatively low."

Thornhill said he expects the desktop market to be "flat to down" in the first quarter, while the notebook market and servers are expected to show some signs of improvement.

During the update, Intel said PC demand was neither stronger nor weaker than initially hoped, but it said the server segment was performing stronger than planned, although the segment isn't big enough to dramatically affect Intel's revenue.

The company is hoping that savings, particularly on the manufacturing cost side, will help it hit its margin estimates, which stand at about 50%.

Pipelining

Of course, investors are likely to be more interested in hearing what the company has to say about the second quarter. It isn't unusual for Intel's revenue to be flat to down 5% sequentially in the June quarter because of seasonal weakness, but Banc of America Securities analyst Douglas Lee said sales could fall as much as 10% from the first quarter.

Aside from seasonal factors, Salomon Smith Barney analyst Jonathan Joseph said the quarter will also be affected by "a bookings correction as the Pentium 4 comes off allocation, and flat (though not lower) second-quarter prices due to April/May price cuts."

Indeed, pricing is likely to be a major issue raised in Intel's conference call. In March, executives refused to answer questions about average selling prices, which have contributed to steep revenue declines despite record unit sales. Although natural technology-driven forces are constantly driving down chip prices, Intel's ruthless price war with

Advanced Micro Devices

(AMD) - Get Report

has amplified the problem.

As for its capital spending plans, analysts expect the firm to reiterate its goal of spending $5.5 billion this year, down from $7.3 billion last year.

Intel isn't likely to be forthcoming about its expectations for business beyond the second quarter, but analysts have high hopes for a much stronger second half, which is why some defend the stock's current valuation.

Joseph believes the PC market will grow by 5% this year, and he expects other end markets to improve along with the economy as the year progresses. "We continue to look for accelerating growth and rising prices through this year and next," he wrote recently.

Small Iron

Thornhill of UBS Warburg agrees that Intel will benefit from a PC upgrade cycle, "which should become evident later this year" as an aging installed base of PCs is refreshed to meet the requirements of the WindowsXP operating system. (Intel said it has not seen any evidence so far that the traditional three-year upgrade cycle would cause a surge in business this year.)

Meanwhile, Merrill's Osha said the launch of the Pentium 4 "Northwood" chip puts Intel in a good competitive position and that investors are underestimating the benefits of this later in the year.

Lee of Banc of America admits that the evidence of a significant pickup in the second half isn't "super-compelling" and certainly not compelling enough to justify Intel's current price-to-sales ratio of 8.6 based on Thomson Financial/First Call's 2003 estimates.

"On an absolute basis,

the valuation is ridiculous," he said.

Still, Lee added that the stock is actually trading at a discount compared with some of its peers.

Analog Devices

(ADI) - Get Report

currently trades at 39 times 2003 estimates, while

Altera

(ALTR) - Get Report

trades at 44 times, and

Xilinx

(XLNX) - Get Report

is trading at 78 times next year's earnings.

"If you're going to put a 40 to 45 P/E on my group, then Intel trading at 28 times '03 earnings isn't so bad," he said.

Whether that philosophy makes investors any money in the current economic environment remains to be seen.

"It is difficult to have conviction in the timing of a recovery at present," noted Bear Stearns analyst Charles Boucher. "The high valuation of semiconductor stocks complicates the investment picture -- if the recovery doesn't meet investor expectations, we think a 30% to 40% correction in the stocks is possible."