25 December 2006

INTC: Analysis through Sept 2006

Down about 20 percent in 2006, Intel was the worst performer in the Dow Jones Industrial Average in a year that turned out to be pretty good for stocks. It will get attention as a rebound candidate from those that subscribe to the Dogs of the Dow theory. Is there evidence to support an expectation of a bounce back? As explained below, we don't see it in the financial results through the quarter ending in September 2006.

Cash Management. Intel's cash management gauge reads 6 out of 25 possible points. When we dig into this, we see that the points reflect the company's first-rate financial strength, rather than operating efficiencies. We don't need to worry for a nanosecond about this company's creditworthiness, but we'll note for the record that the current ratio is a solid 1.94. This figure is down somewhat from previous years, probably because the company has been using its cash hoard for capital investments and to buy back stock. Long-term debt to equity is a scant 6 percent, which might be surprising given how expensive it is to build and retool chip foundries. Accounts receivable are 34 days of revenue, which is down a bit (good) from recent levels. On the other hand, and this is important, the company is holding 101 days of inventory, as measured by the cost of goods sold. This is the highest inventory level in 10 years and far above the five-year median value of 67 days. When coupled with the fact that finished goods constitute 37 percent of inventory, which is at the upper end of its historic range, we can't be optimistic about future revenue growth and pricing power.

Growth. The growth metrics are horrible, with the company undeserving of a single point of the 25 possible on the growth gauge. Revenues are down 6 percent year-over-year. Cash flow from operations is down 33 percent. Net income is down 28 percent. Revenue/assets is 77 percent, down from 81 percent a year ago, but within the historic range.

Profitability. Also dismal. This gauge reads 5 out of 25 points. The accrual ratio is +4 percent. A negative number is preferred for this ratio, and it was negative for Intel a year ago. The return on invested capital in 17 percent, which is the slimmest ROIC figure in the last 3 years. At 12 percent, free cash flow to equity has taken an even steeper decline. And, to put the final nail in the coffin, a 79-percent ratio of operating expenses to revenue is 10 percentage points higher than a year ago.

Valuation. A sad 4 of 25 possible points. This suggests that the fall in the stock price hasn't been painful enough to account for the poor operating performance. Since net income is contracting, the PEG ratio is meaningless. The trailing P/E ratio is 20, a 30 percent premium to the market, which is odd unless one knows of a reason (Vista?) to believe future earnings growth will outpace the market. Price/Sales, down to 3.3, is the one sign of value; it suggests that a turnaround in revenues might translate into a stock price gain.

Overall. Rolling up all of the above, the overall gauge stands at a weak 16 out of 100 possible points. It's almost sad to see how fast this once-mighty bellwether has fallen. However, the semiconductor market is notoriously cyclic. Intel has bounced back before from bad market conditions. Will there be early warning signs of a comeback? We would look first at the total inventory level and then at the finished goods component of the total inventory. A drop in these figures, assuming no inventory write-down, would indicate an uptick in demand for the company's products.

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