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Intel Profit Shatters Forecasts

Strong demand for PCs during the holidays helped the chip giant leap over analysts' estimates for the fourth quarter.

SAN FRANCISCO -- Investors can't be anything but pleased after


(INTC) - Get Free Report

reported fourth-quarter earnings per share of $1.19, beating the

First Call

estimate of $1.07 and the whisper number of $1.10. Heck, Intel even beat

Morgan Stanley Dean Witter

analyst Mark Edelstone's bullish estimate of $1.12.

In a conference call, Intel said it found itself unprepared for the huge demand by PC buyers last quarter. To meet the surge in demand during the Christmas season, Intel shifted production away from its low-priced


chips to fulfill demand for its higher-priced and higher-margin


. "We believe we underbuilt our inventories," Intel CFO Andy Bryant said. "We left the quarter with unfulfilled demand. We are still struggling to get ourselves to a point where we are comfortable going into the next quarter."

That unexpected demand did two things. It boosted Intel's gross margins to 58%, three percentage points higher than what the company preannounced in November and six points above the third quarter's margin. But it may also have given archrival

Advanced Micro Devices

(AMD) - Get Free Report

an unexpected advantage in the low-cost PC sector.

In the third quarter, Intel lost its lead in the U.S. retail desktop market to AMD, thanks to AMD's control of the low end. Paul Otellini, general manager of Intel's Architecture Business Group, said he is determined to reverse that trend. "If we don't have more success in the U.S. retail in the next six months than in the last six months, I will be very disappointed," he said.

That's why Intel is drawing a line in the sand. "They are basically saying enough is enough," said

C.E. Unterberg Towbin

analyst Claude Hazan. Should AMD build up enough of a financial cushion through low-end sales, it can spend that much more R&D and marketing money in the more lucrative high end of the market, Hazan says.

For all Otellini's determination to beat AMD, he seemed frustrated by analysts' obsession with the low-end battle. "I need to caution you that U.S. retail is not the be all and end all for home PC consumption," Otellini said. "You need to look at all the elements."

Intel also saw a healthy recovery of its Asian sales in the fourth quarter, particularly in China. Hazan calculated that Intel saw a 45% increase year-over-year sales to Asia last quarter.

Overall, Hazan liked what he heard. So what's the problem? Valuation. Intel closed today at 135 9/16, down 4 for the day. "I see earnings of $5 for 1999 and $6 for 2000," Hazan said. That gives it a price-to-earnings ratio of 27 for this year and 22.5 for 2000. "I think the stock is worth 150, but I'm not going to pound the table for it," he said.