I’ve learned that one of the fastest ways to fill up my mailbox with colorful email messages is to say something bad about America’s favorite tech companies.
But I’m ready. I can handle it.
So today, I’m going to revisit Intel, one of America’s most beloved companies, but also the company I’ve been warning you about the longest and loudest. I repeat:
Get Out of Intel While
The Getting’s Good
(Or at Least Still Possible)
Would you have been better off getting out the first time I warned you? Or the second? Or third time?
Sure, but past is past, and now’s better than never.
Why? One reason is the horrible Q1 report Intel delivered last week. It means to me that this stock still has a long, long way to fall.
The company certainly has a big following. Heck, thanks to its clever “Intel Inside†advertising campaign, it has become one of the most widely recognized brands in the world.
It’s also one of the most widely owned stocks: Individual investors and mutual funds all over the world are loaded up to the gizzards with Intel shares.
Just in the past 90 days, Fidelity Equity Income II (FEQTX) has bought 9.4 million shares of Intel …
Putnam Voyager (PVOYX) has bought 3.7 million …
DWS Growth & Income (SCGDX); 3.4 million …
And funds like Vanguard Windsor (VWNDX), Fidelity Growth & Income (FGRIX), MFS Value (MEIAX) and Fidelity Blue Chip Growth (FBGRX) have also bought heavily.
My view: Anybody that’s still a big Intel fan after last week must be afflicted with the common Wall Street “hear-no-evil†disease.
Reason: Intel delivered its quarterly report for the first three months of 2006, and I think it was a total disaster. The mainstream media and Wall Street, however, acted like nothing happened because Intel reported earnings of 23 cents a share, which is exactly what the Wall Street crowd was expecting.
Problem: Anyone who bothered to look at the devil in the details would have seen the signs of a sinking chip ship.
We’ll start with a very telling statement from Intel CEO Paul Otellini:
“We believe PC growth rates have moderated over the course of the past few quarters, leading to slower chip-level inventory reductions at our customers and affecting our revenue in the first half of the year.â€
“PC growth rates moderated?â€
That’s nothing more than a gentle way of saying that business is shrinking. As I’ve said many times, computers aren’t going away. But they are morphing into a mature, slow-growth business.
Heck, Otellini himself lowered his forecast for overall PC industry growth. It will fall to single digits in 2006 instead of the 11% to 12% he previously forecast at the beginning of the year.
Frankly, whenever a CEO tells you that business is slowing down, you should believe him. But even if you don’t want to believe Otellini, the evidence of that slowdown is splashed all over Intel’s first quarter results.
Slowdown sign #1: At the beginning of the year, Intel bragged that it would increase its revenues by 6% to 9% in 2006. Wrong! Intel now says that its revenues will drop by 3% in 2006!
Slowdown sign #2: Intel’s 23 cents of profit translates into $1.3 billion, which sounds like a lot … until you realize that it’s 38% less than the company made during the first quarter of 2005. (Revenue
fell from $9.43 billion last year to $8.94 billion this quarter.)
Slowdown sign #3: Intel said its second-quarter revenue will be between $8 billion to $8.6 billion, which is way below the Wall Street forecast of $8.85 billion.
Slowdown sign #4: If a company expects its business to slow, it makes good sense to cut expenses. That’s exactly what Intel is doing. It announced that it would cut its capital and R&D spending by more than $1 billion in the second half of the year.
By the way, that’s a very sharp contrast to Advanced Micro Devices, which boasted at the beginning of April that it would boost its equipment spending by about $300 million, to $1.7 billion.
Intel’s Balance Sheet Slipping
In the tech boom of the 1990s, most analysts were glued to the earnings reports but neglected everything else, including deteriorating balance sheets.
That’s one reason why I pay more attention to the numbers buried in the fine print than I do to the promises that come out in press releases. And with Intel, I’m finding some waving red flags:
Red flag #1: The main reason Intel was able to report 23 cents of profit was because of old-fashioned, financial smoke and mirrors.
- Intel reported a much lower-than-expected income tax rate: 27.5% versus Intel’s own January forecast of 32%. Without this tax bill reduction, Intel would have missed its estimate by a mile.
- The expense side of Intel’s income statement came in at $3.2 billion, $100 million lower than the $3.3 billion forecast. That’s good. But if revenues continue to slide, they can only cut expenses so far.
Red flag #2: Intel’s Swiss-cheese balance sheet. It’s full of holes:
- In the last 12 months, Intel’s cash horde has shrunk from $11.3 billion to $7.8 billion. That drop is especially telling when you realize that Intel floated a $1.7 billion convertible bond six months ago. Talk about a cash burn!
- That cash cushion would be even smaller if it weren’t for the not-so-clever accounting trick of letting bills pile up. Intel’s accounts payable soared from $6.32 billion to $7.09 billion in the last quarter.
- If Intel was sitting on too much inventory last quarter, then it’s really sitting on way too much inventory now: Inventory ballooned from $3.12 billion at the end of 2005 to $3.55 billion. That’s $400 million of new, unsold inventory in just 90 days.
- Worst of all, Intel admitted that its customers (probably Dell) were already holding several million excess chips in inventory. That tells us that the second quarter is going to be even uglier.
Red flag #3: One of the biggest problems of businesses that have huge fixed expenses — such as billion dollar chip plants — is that profit margins collapse without big sales volume. Last quarter, Intel saw its gross profit margins shrink from the 57%-61% range it promised as recently as January to only 55.1%.
Moreover,
Intel quietly admitted that gross margins would fall to 49% for the rest of the year!
All these devilish details paint a picture of a company in trouble, but there’s one more big problem I need to address:
False Hopes
Looking ahead, Paul Otellini boasted that a big rebound is right around the corner.
He based that hope on the expected launch of several new chips later this year. These new chips, called “Conroe†and “Woodcrest,†are expected to ship in the third quarter, with the expectation that they will propel Intel to great new heights and amazing profits.
My take on this: The new chips won’t do much to resuscitate Intel’s revenues. But they sure as heck can saddle Intel with billions of outdated chips!
You watch. It won’t be long before you hear Intel pre-announce a giant profit shortfall and blame it on a write-off of obsolete inventory. That warning could send Intel shares into another tailspin.
Live by the Sword,
Die by the Sword:
How to Connect
The Dots to Dell
It doesn’t take a genius to realize that Intel’s great success has coincided with Dell’s dominance of the PC business.
To this day, Dell uses exclusively Intel processor chips in 100% of the computers it makes, and, until not long ago, Intel was riding Dell’s coattails to staggering growth and profits.
So it isn’t an overstatement to say that Intel’s future is very tied to the ups and downs at Dell. But guess what! Dell’s dominance of the PC business is disappearing.
The two main PC industry watchdogs — Gartner Research and IDC — both recently released their studies of the PC business and found that Dell, while still #1, is rapidly losing ground.
According to Gartner Research, Dell’s market share of the PC business dropped from 16.9% to 16.5% in the last 12 months. IDC was a little more generous, calculating that Dell’s market share has shrunk from 18.6% to 18.1% during the same period.
But no matter what, according to Loren Loverde at IDC, Dell is in trouble. His words:
“This was the first time in Dell’s history that we’ve seen almost no growth, and the first time since 1996 where growth was below 5%.â€
You don’t have to look very far to figure out what ails Dell. All you have to do is look across the Pacific Ocean to see who’s stealing Dell’s market share:
Lenovo (China), Acer (Taiwan), and Fujitsu Siemens (Japan) have grown from minor pests to formidable competitors.
Bottom line: Intel’s and Dell’s days are numbered.
Think I’m full of baloney?
Then ask yourself why both Dell and Intel shares hit new 52-week lows last week? Yup, new 52-week lows.
And while Dell and Intel were tanking, the Chinese market has been soaring. The Shanghai Composite Index is up by 18% so far this year and the Shenzhen Composite Index is up by almost 25%.
As an investor, you’ll have to choose. Do you want to invest in best-known U.S. brands that are sinking … or not-so-well-known Chinese, Japanese, South Korean or other brands that are rising?
Deng Xiaoping once put it this way:
“It does not matter if the cat is black or white,
as long as it catches the mouse.â€
Ditto for tech stocks. It doesn’t matter what side of the world it’s on … as long as it makes you money.
I’m not suggesting that you completely abandon the U.S. market. What I am urging you to do, however, is to add some Asian spice to your portfolio. The more the better, within limits of course.
Plus, as Martin always reminds me, don’t forget the cash. You should always keep plenty in reserve, and in a place that’s as far away from risk as you can get it.
Best wishes,
Tony Sagami
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About MONEY AND MARKETS
MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Jennifer Moran, John Burke, Beth Cain, Red Morgan, Ekaterina Evseeva, Amber Dakar, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others.
© 2006 by Weiss Research, Inc. All rights reserved.
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