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Intel: Why the Street Sees a Good Bet

By Cliff Edwards When Intel announced its first-quarter earnings back in April, Wall Street wasn't much impressed. The chipmaker reported rising inventories, a lawsuit settlement that cut into earnings, and ho-hum outlook for sales through June. Since then, its stock has been in the doldrums, trading at between $26 and $29.

The news isn't expected to be much better after the markets close June 3, when the company provides an update on second-quarter sales. Analysts expect Intel (INTC) Chief Financial Officer Andy Bryant to report that sales in the quarter to date have been seasonally normal, with the traditional wildcard Father's Day/graduation shopping period late in the quarter determining its success. Many analysts expect Intel to narrow revenue guidance to between $7.8 billion and $8 billion from previous forecasts of between $7.6 billion and $8.2 billion. Inventory levels are expected to remain at close to three-year highs.

Now, however, investor sentiment is vastly different. Thirty-three analysts recommend buying the stock, up from 27 three months ago. Take Goldman Sachs analyst Andrew Root: "Intel continues to be our favorite semi stock."

CHIPS GALORE. Why is the tide turning? The long-awaited corporate replacement cycle is gathering steam, says analyst George Shiffler at research firm Gartner. He predicts 100 million PCs are likely to be replaced this year, with another 120 million to be swapped out next year. And since Intel typically commands about 80% of the chip market, that's one major reason investors should be smiling.

Intel's company-specific factors also give investors reason for optimism. Already, juicy gross margins of about 60% are expected to improve steadily over the next year, as both consumers and businesses opt to purchase notebook PCs over desktops. On top of better margins, notebook sales also should help boost Intel's bottom line, with strong sales of Wi-Fi chips as part of the Centrino wireless package.

The second half of the year will bring a slew of new products, including graphics and sound chips, higher clock speed desktop and notebook chips, and new versions of its hot-selling Xeon server chips.

OPTIONS CONTROVERSY. Even resurgent competition from rival Advanced Micro Devices (AMD) likely won't dim Intel's fortunes (see BW Online, 5/19/04, "AMD: Barely an Underdog?"). While AMD's Opteron and Athlon 64 chips are helping boost its bottom line by increasing its average selling price, analyst Dean McCarron at Mercury Research reported May 3 that Intel's worldwide market share in the first quarter barely budged. AMD also is constrained by the number of factories in which it can produce chips, while Intel is ramping production over the next year on five cutting-edge facilities capable of churning out massive numbers of processors.

One factor weighing on Intel's stock: potential federal rules that would require expensing of stock options. Despite steadfast objections from company management, some 54% of Intel shareholders voted last month in favor of a nonbinding proposal to begin expense options. An Intel spokesman says management will wait at least until federal rules are clarified to consider changing its policy against expensing. Intel Chairman Andy Grove argues there's no way to legitimately value options, and that doing so would muddy financial reporting.

The specter of higher interest rates also continues to affect semiconductor stocks. Since January, the SOX index for the sector has slipped nearly 15% from its high. Still, Intel's increasingly diversified product portfolio, which now extends to processors and memory chips for handhelds and cellular phones, should insulate it from any potential slowdown in business spending.

PAYDAY? Analysts believe there's plenty of upside to Intel shares. The chipmaker is now trading at a price-to-earnings multiple of 23, lower than its 10-year median of 24.8 times forward earnings. That translates into a target of about $36 a share. For 2005, current estimates put p-e at a very conservative 19, suggesting big gains toward the end of the year if Intel's product transitions proceed smoothly.

Intel made big bets during the long industry downturn. And it looks like the moves may soon be paying off. Edwards covers Intel from the San Mateo bureau of BusinessWeek

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