Intel Will Be Graded on the Margins

This stock's climb may continue if Tuesday's earnings report includes a boost to margin targets.
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Intel's

(INTC) - Get Report

stock is on the rise -- and so are its margins -- but there may be more room for both to expand further.

Intel will report second-quarter financial results after the closing bell Tuesday with its stock on a three-month climb to $28.23, just under its high for the year.

Analysts are expecting earnings of 32 cents a share on sales of $9.22 billion, on average, according to Thomson First Call. But the key numbers for Intel investors -- and the primary drivers of its stock going forward -- will likely be the company's third-quarter projections and its expectations for gross margins through the rest of the year.

During a

midquarter update in early June, Intel boosted financial and gross margin targets for the quarter, but it declined to comment on full-year margin goals. At that time, Intel said results were tracking seasonal expectations, with an upside in notebooks.

The company boosted sales expectations to between $9.1 billion and $9.3 billion and gross margins of 57%, up from earlier targets for sales of $8.6 billion to $9.2 billion and margins of 56%. Also, Intel said its bottom line would benefit from a reduced tax rate of 26% and gains from equity investments and interest around $100 million.

For the full year, Intel's margin target stands at 59%; this expectation was raised in April from 58% after Intel logged a strong first quarter. (Intel logged its highest margins of 62.5% in 2000).

The biggest factors helping gross margins are the shift to notebook computers from desktop PCs and strong demand by corporations for servers. Margins are higher for the chips used in these products.

And last week, Intel's smaller rival AMD

cited both of these factors as reasons for its better-than-expected results in the second quarter. AMD also said it expected these trends to continue into the third quarter.

This should help Intel even more, as it dominates the laptop and server chip market. Further, Intel is benefiting from reduced start-up costs and increasing utilization rates at its factories.

Based on current projections, Intel is expected to book 52% of its sales in the final six months of 2005, and with a growing portion of those sales coming from laptop computers, margin expansion should be easier to come by. At the year's start, Intel predicted most of its margin improvement would occur in the third and fourth quarters.

Looking ahead to the third quarter, analysts are expecting earnings of 36 cents a share on sales of $9.76 billion. However, consensus estimates have been on the increase during the past 90 days, and another boost higher by the company to its full-year gross-margin target will likely force analysts to again tweak their models. During this same 90-day period since mid-April, shares have been storming higher, with the latest run lifting the stock 20% for the year.

It took Intel's stock almost a year to

break firmly above $25. The next battleground is at $29 and if full-year gross margins get ratcheted up again, Intel bulls likely won't take a year to topple that level.