Prepared byMorgan Stanley Dean Witter analysts Mark L. Edelstone, John Cross, Louis P. Gerhardy, and Gary Chia
NASDAQ: INTCPrice (Oct. 17, 2000): $36.1952-Week Range: $75.81-32.50
Summary and investment conclusion
After the market closed on Oct. 17, 2000, Intel reported results that were better than the preannounced guidance on Sept. 21, 2000. Revenues increased 5 percent sequentially and were at the upper end of guidance. Gross margins of 64 percent were higher than guidance and came in about where we expected originally.
The surprise was flat sequential unit shipments. When we consider the disconnect of strong MPU shipments in the first half of the year compared to PC shipments combined with the weak third-quarter results, we believe the stage is set for fourth-quarter growth.
This pattern of demand is consistent with that experienced by the DRAM market and PC food chain over the last two quarters and helps to explain the unusual seasonal patterns.
Intel set the bar low with fourth-quarter revenue guidance of 4 percent to 8 percent growth, and with clean channel inventory, we believe Intel could achieve 9 percent growth. As a result, we have increased our fourth-quarter earnings-per-share estimate from $0.42 to $0.44, which is likely to be above consensus.
We believe the weakness in INTC is overdone, and the stock is likely to remain in a trading range over the next 12 months. However, we believe the stock is probably at the lower end of the range now, and it should begin to recover some of the recent losses. We maintain our 2001 EPS estimate of $1.75 and reiterate our Outperform rating and $60 price target.
All regions grew except Europe
In the third quarter, revenues from Europe grew 5 percent sequentially and were flat year-over-year. In the second quarter, Intel experienced very strong demand from the Americas and believed that demand in Europe would be stronger than usual in the third quarter. Instead, Intel found that demand in Europe slowed significantly in mid-September due to general economic weakness, pressure from the Euro, and rising oil prices. In contrast, demand in Japan and Asia-Pacific has remained strong.
Due to the shortfall in revenues, Intel increased inventories. Inventory increased to 56 days in the third quarter compared to 47 days in the second quarter. Distribution inventory was flat with the second quarter. On a historical basis, this inventory level is low, and Intel has sought for over a year to increase inventories to enable more flexibility and responsiveness in its business. Intel expects normal growth patterns in all geographic regions in the fourth quarter.
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Ahead of plan on conversion to 0.18-micron manufacturing
Intel's better gross margins of 64 percent in the second quarter reflect the successful conversion to 0.18-micron production (greater than 90 percent of volume), yet Intel remains capacity constrained. Demand for flash memory remains quite strong, and Intel has commenced shipments of flash from 0.18-micron manufacturing.
In addition, Intel's fast-growing networking, communication, and wireless products are placing increasing pressure on manufacturing expansion. We believe Intel is on track to start to transition to 0.13-micron production in the second half of 2001.
Non-MPU business grew 18 percent sequentially, with particular strength in chipsets
In the third quarter, chipsets were one of the fastest growing product lines and grew at least 20 percent in revenues sequentially. In addition, motherboard unit shipments increased significantly, and we believe these are good leading indicators for MPU sales.
Intel increased its market share in the chipset market in the third quarter and is focused on further market share gains. Chipset supply had been constrained in the first half of the year, and with increased production capability, Intel has been able to get back to the typical pattern where sales of motherboards and chipsets tend to lead microprocessor sales.
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Focus at Intel is driving the Pentium 4 transition
The Pentium III generation is entering its last couple of speed enhancements and entering the tweak phase of life. We believe the Pentium III is currently limited to 1 GHz until the revamped 1.13-GHz Pentium III comes out in 2Q01. With limited frequency headroom in Pentium III, Intel could lose pricing power in that product line. Until the Pentium 4 ramps, Intel is likely to face increased competition.
Intel's focus is on launching the Pentium 4 microprocessor in November and ramping shipments faster than the Pentium III generation. In 2001, Intel plans to bring on additional capacity for its premium products (Pentium 4 and Itanium) and expects to drive lower per unit costs over the next three quarters.
We believe the Pentium 4 die size is a significant premium to Pentium III and that it will take twice as many wafers to build the same number of Pentium 4 MPUs (compared to Pentium III) on 0.18-micron technology. Although Intel will be working to reduce costs on 0.18-micron, we believe Pentium 4 needs to enter 0.13-micron production to hit mainstream, high-volume price points.
At the Microprocessor Forum, Intel positioned the Pentium 4 for power users and PC enthusiasts in the high-performance desktop category. Pentium 4 is designed for where the Internet is going when high bandwidth access is readily available (most still dial up over 56K modems). We believe Intel's ability to manage the transition to Pentium 4 and 0.13-micron production are key factors for success in 2001.
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