Intel Investors Abandon Chips

Investors agree that the quarter is a wash but differ on what the chip leader will do to right its course.
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One company's loss is not necessarily the other's gain.

Advanced Micro Devices

(AMD) - Get Report

disappointed the Street with its

cautionary outlook last week, but few investors are expecting arch rival

Intel

(INTC) - Get Report

to shine when it reports its own first-quarter earnings after the bell Wednesday.

Intel, of course, already

preannounced that its revenue would fall short of its initial projections, and its stock, which has been languishing at or near its 52-week low for much of the past week, reflects how little investors expect from the world's No.1 chip company.

The average analyst estimate calls for revenue of $8.91 billion, just above the midpoint of Intel's revised guidance of $8.7 billion and $9.1 billion. That would represent a 12.6% sequential decrease, vs. the 6.8% sequential decrease that has been Intel's first-quarter average for the past five years.

All eyes will be on Intel's revised business and spending outlook for 2006, given the company's acknowledgment in the March warning that its initial budget was no longer valid.

"That's probably going to be the most important part of the call," says American Technology Research analyst Doug Freedman.

The tack Intel takes regarding its capital expenditures, R&D and other expenses will provide critical clues about how the company views the market in light of recent struggles and how management intends to respond, says Freedman, whose firm has no banking relationships with the company.

Intel's initial forecast, delivered in January, called for aggressive spending increases. Capital expenses were slated to improve 19% to $6.9 billion in 2006, while research and development spending was set to rise 27% to $6.5 billion.

Deviating from Intel's typical practice, the planned spending growth rate for 2006 exceeded Intel's projected revenue growth for the year. Analysts viewed this as a sign of Intel's commitment to crank up the heat on AMD, which in recent quarters has been chipping away at Intel's dominant share of the PC microprocessor market.

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.

But with Intel's revenue now projected to be even less than expected, analysts and investors are wondering which part of Intel's budget will be targeted for a haircut.

Needham & Co. analyst Charlie Glavin says that any cost savings will come from operating expenses, most likely by Intel opting not to refill vacant job positions. He considers it unlikely that capital expenses will be trimmed.

"This would be too myopic and inconsistent with how Intel normally makes capex decisions," wrote Glavin in a recent note to investors in which he maintained his hold rating on the company's stock.

Budget Blues

According to Glavin, Intel typically sets the capital-spending budget during its global strategic review in November and makes any modifications in June.

And "if Intel is to match AMD and implement its 2006-07 multiproducts road map (including its quad-core Clovertown chips next year), we could even argue that Intel needs to increase capex," wrote Glavin, whose firm makes a market in Intel shares.

A.G. Edwards analyst David Wong is also skeptical that Intel will cut capital expenses. "Given that much of the capital spending is directed at the 45nm transition rather than capacity increases, Intel may have little ability or desire to significantly reduce capital spending," wrote Wong.

But Wong believes that one of the biggest eye-openers in Wednesday's quarterly earnings report will be the chip giant's inventory levels.

"Inventory information will be particularly relevant and, we think, more important to investors in many ways than the sales or earnings that Intel reports for March or guides to in June," Wong wrote in a recent note to investors. A.G. Edwards has received compensation for non-investment-banking services from Intel during the past 12 months.

According to Wong, Intel's inventory could reasonably be expected to have risen by several hundred millions of dollars during the first quarter and could accrue an additional $100 million to $200 million in the second quarter.

Because the inventory level at the end of the June quarter will affect whether Intel is able to achieve a gross-margin recovery in the second half of the year, Wong says there is a chance that Intel could take a charge to write off some inventory in the first or second quarter.

Intel had originally set its 2006 gross-margin target at 57%, plus or minus a few points. But it's unclear what margins the company is aiming for, now that it has scrapped its original 2006 outlook.

The only hint offered by Intel is that its first-quarter gross margin, initially pegged at 59%, plus or minus a few points, will be "adversely impacted."

Analysts polled by Thomson First Call are looking for Intel to earn 23 cents a share in the first quarter and 21 cents in the second quarter. Intel earned 34 cents a share in the first quarter of 2005.

Shares of the company were recently trading at $19.39.