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Intel Fails to Light Fire

Improved outlook doesn't offset AMD price war and lagging PC demand.

After suffering through several painful quarters of readjustments,

Intel

(INTC) - Get Intel Corporation Report

showed investors the light at the end of the tunnel.

The chipmaker raised its profitability target for the second half of the year, suggesting that its turnaround plan and its new lineup of chips were beginning to pay off.

The improving outlook earned the company a couple of upgrades from Wall Street brokerages, with JPMorgan and American Technology Research both upping Intel to buy and overweight, respectively.

But investors were more restrained, moving Intel's shares up a moderate 1.1%, or 23 cents, to $21.21 in Wednesday midday trading.

Additionally,

Advanced Micro Devices

(AMD) - Get Advanced Micro Devices, Inc. Report

, Intel's main rival, saw its shares get a bigger lift on the news, rising 3.8%, or 51 cents, to $13.98.

With Intel and AMD locked in a fierce price war and demand for PCs in a seasonally slow period, the 1-point gross margin increase that Intel put on the table was not enough to make its shares more palatable.

Even Intel bulls acknowledged that new 2007 margin expectation of 51%, vs. the prior estimate of 50%, would have a minimal impact on the income statement.

UBS analyst Uche Orji said the improved margin will be washed out by an increase in the tax rate from 30% to 31%, leaving Intel's 2007 EPS ultimately unchanged at $1.09. In 2008, Orji sees EPS increasing by a modest 2 cents thanks to the rising margins.

UBS makes a market in Intel shares and has provided the company with noninvestment banking services in the past 12 months.

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Regardless of the full-year outlook, some investors could not look past the near-term guidance.

The chipmaker served up lower-than-expected revenue and gross margin estimates for the second quarter, causing some analysts to pare back their earnings estimates.

"The simple takeaway is they lowered Q2 EPS from 23 cents to 19 cents," says Sangeeth Peruri, semiconductor analyst at Seligman Technology Group.

The fact that Intel's stock is up at all on that change is curious, says Peruri, whose firm has a position in Intel shares.

As it turns out, the various guidance updates contained in Tuesday's report haven't really altered the basic trajectory that many investors were charting for Intel.

Before Tuesday's earnings report, investors expected Intel to have a lackluster second quarter, with growth coming in the second half of the year.

Tuesday's call reaffirmed that script, except that the second quarter will now be even worse than expected, and the second half of the year will be better than expected.

Even so, Intel bulls were encouraged by the fact that average selling prices for desktops and mobile chips held steady in the first quarter.

"People were looking for ASP

average selling price erosion," says Jim Grossman, a portfolio manager at Thrivent Investment Management, which owns Intel shares.

Intel's stabilizing ASPs suggests that the company is able to sell its chips without resorting to price cuts, say some analysts. And that means that Intel's profit margins could be poised for further increases than Intel talked about Monday.

What happens when AMD refreshes its product lineup is an open question. Intel's current pricing leverage owes largely to the fact that it's competing against AMD's older generation of microprocessors. AMD is expected to release a new and improved quad-core chip, dubbed Barcelona, later this year.

Intel CEO Paul Otellini told investors Tuesday that he expected to maintain the competitive lead in servers and high-end desktops even after Barcelona's release.

"Even though

Barcelona is a more competitive product than they are shipping today, I think it's going to come down to the ramp," said Otellini, referring to AMD's ability to produce the new chips in volume.

If Intel hopes to see even the modest increase in gross margin it has targeted, Otellini's assessment of the competition better be right.