Wednesday, July 15, 2009

No Reason to Cheer Intel's Earnings

The predictably upbeat reception that was held for Intel (INTC) following the Company's Q2 earnings release, after hours yesterday, featured the well-told storyline that the economy has bottomed, and prosperity is just around the corner. To it's credit, Intel has managed to operate efficiently throughout the recession, reporting a quarterly revenue decline of only 15.2% compared to the same quarter in 2008. They've also taken the EU fine in stride, booking the $1.45B charge for Q2 and moving on. However, we take issue with any attempt to characterize these results as indicative of a pending turnaround in the Broader Economy.

First of all, to reiterate one of our common themes, Intel was able to "surprise" analysts through a combination of "less bad than expected" sales and, very importantly, across the board reductions in operating expense. Obviously, any comparison to Q2 '08 must take into account that oil was priced at ~$140/bbl; exerting upwards pressure on ANY petroleum based product. In addition to the cost-of-goods benefits, Intel clearly made the decision to trim it's marketing/G&A and research and development expenses. Compared to Q2 '08, these expenditures declined 12.5% and 11.2% respectively. Across both categories, these percentages represent cost cuts totaling $345M. This is important considering that one of the key figures cited by bulls as "surprisingly good" was the Company's Q2 gross margin percentage of 50.8% - a handful of percentage points above stated guidance of "mid-40-ish". This "surprise" is more than explained away by the substantial reductions to operating expense.

Secondly, the reaction to INTC's results shows the ability of economists to spin just about anything. For the past several months, economists have espoused the view that according to official inventory figures, the economy in general should benefit from a "re-stocking" effect in the second quarter as companies re-stock their barren inventories with new product. Surprisingly though, as soon as the oft-cited inventory dynamic begins to appear in corporate earnings reports, we are supposed to believe that this new demand is being driven solely by a stabilizing economy. We certainly aren't buying it.

*no position in INTC
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