Intel surprise should lift the market, but what is really going on??

Most on the Wall Street expected INTC to narrow its revenue guidance to $8.9B to $9.2B from prior wider guidance of $8.6B to $9.2B. Most expected INTC to remain fairly conservative and especially gross margin guidance was expected to remain unchanged at 56%. There were even some who expected INTC to just maintain its prior guidance and perhaps lower gross margin guidance. INTC however surprised the street by raising the revenue forecast to $9.3B to $9.5B and to add fuel to the fire gross margin expectations have potential of coming in higher as well. The guidance for gross margin was changed to 55% to 57% versus 54% to 58%, which if I do my math correctly seems the midpoint is same in both cases.

Better enterprise spending was indicated by many PC related companies such as DELL, HPQ, TECD. Server units were certainly stronger as noted by OEMs. Notebooks seemed to have picked up due to falling LCD prices and the pickup in units and better mix is certainly better than INTC had expected. Higher units of server chips and notebook chips certainly help gross margin because these chips carry higher price tag.

INTC management said the higher demand was across the board. Inventories which have been another area of concerns should decline as expected. Gross margins were helped by some accounting gimmicks, however higher demand does help margins.

Historical fourth quarter growth for INTC is 10.7%, so the new guidance of up 11% (at mid point of range) is in line with historical growth. Is this real pick up in demand or is it is just relative because INTC expectations were tempered to begin with? Overall the PC market is tracking to seasonal sequential growth, nothing extraordinary and INTC it self has been little weaker than market due to inventory build up and draw downs. Last quarter INTC grew less than seasonality so this quarter could be just to make up for lost growth in Q3 or did they not ship enough in Q3 to help Q4? Questions remain on where the growth will come from in next twelve months and how the margins can be expanded in this environment. Which begs the question, if this demand is artificial, what happens to inventories in Q1 2005 with INTC utilizing its factories more to produce more? Do we go back to the cycle of over builds and draw downs next year? INTC certainly isn’t going to slow its factories down because that would hurt margins and they said utilization is bottoming. Is utilization bottoming because they do not use the older 200mm fabs and need to run a lot more units through the newer 300mm fabs to maintain the same margins?

Plain and simple INTC has too much capacity and not enough demand, it can play the inventory games for a while but sooner or later it will catch up and that’s when you don’t want to be holding INTC. With all these questions its tough to say all is well with INTC. Certainly the market will take semiconductor and most tech stocks higher tomorrow, but if you are not like many glorified day-traders (they call themselves Hedge Funds sometimes) then think about what could happen next not what has happened already.

P.S. If any of the somewhat-technical talk about fabs is too complicated for you, please feel free to ask questions.