03 November 2007

INTC: Financial Analysis through September 2007 (Updated)

Intel's (INTC) preliminary financial results for the quarter that ended on 29 September 2007 did not include a complete Cash Flow statement. In our original analysis of these results, we estimated Net Cash from Operations (CFO) from other data. Intel subsequently submitted a complete set of financial statements, which included the Cash Flow data (better than we expected), in a 10-Q filing to the SEC.

There were other differences between the figures in the preliminary report and the figures in the 10-Q. Minor adjustments are not unusual, but one was quite significant: the stated Cost of Goods Sold (CGS) increased from $4.806 billion to $4.919 billion. Did Intel discover an additional $113 million of payments? By scouring the 10-Q, we discovered that Intel charged $113 million to CGS to account for the present value of intellectual property licensed as the result of a settlement with Transmeta. This extra expense reduced Net Income by $69 million.

We have updated our analysis to factor in the newly available data. The net effect of the higher than estimated CFO, the increased CGS, and the various lesser changes was to increase the Growth gauge from 7 to 8 points, the Profitability gauge from 11 to 13 points, and the Overall Gauge score from 27 to 30 points.

Intel (INTC) manufactures integrated circuits for computers, servers, handheld devices, and communication products.

After a year in which Intel was the worst performer in the Dow Jones Industrial Average, the stock price started a significant recovery in April 2007. Outpacing the broader market, investors realized that rosier times were ahead for Intel.  Favorable reviews given to Intel's newest products led to predictions that Intel would regain market share from steadfast competitor Advanced Micro Devices (AMD).

When we analyzed Intel after the second quarter, the Overall score was a disappointing 20 points, suggesting the stock rally might run out of steam. [In reality, Intel shares were up another 9 percent in the third quarter; our scores correlate better with price changes 12 months in the future.] Of the four individual gauges that fed into this composite 20-point result, Cash Management was the strongest at 10 points. Value was weakest at 1 point.

Now, with the available data from the September 2007 quarter, our gauges display the following scores:

Before we examine each gauge, let's compare the latest Income Statement to our expectations. (The table below includes the charge associated with the Transmeta settlement.)

Sept 2007
Sept 2007
Sept 2006
10090 9300 8739
Op expenses

CGS (4919) (4465) (4445)

R&D (1521) (1395) (1389)

SG&A (1378) (1395) (1425)

Other (128) (150) (106)
Operating Income
2144 1895 1374
Other income

Investments 148 0 168

Interest, etc. 211 320 272
Pretax income
2503 2215 1814
Income tax
(712) (643) (513)
Net Income
1791 1572 1301

0.30/sh 0.27/sh 0.22/sh

Revenue was a substantial 8.5 percent greater than the estimated value, which was the midpoint of the range forecast by the company in July. Instead of a predicted 6.4 percent increase, Revenue was 15.5 percent greater than in the year-earlier quarter.

The company estimated that Cost of Goods Sold (CGS) would be 48 percent of Revenue, and the actual value was 48.8 percent (1.2 percent of which can be attributed to the Transmeta deal). Research and Development (R&D) expenses were 15.1 percent of Revenue, essentially identical to our 15 percent estimate. Sales, General, and Administrative (SG&A) expenses were 13.7 percent of Revenue, quite a bit better than our forecast of 15 percent.

The net effect of the higher Revenue and lower SG&A expenses was Operating Income 13.1 percent above the forecast value.

Non-operating income was $39 million greater than expected. The Income Tax Rate was 28.4 percent, a little below the predicted 29 percent. Net Income exceeded our prediction by a healthy 13.9 percent.

Cash Management. This gauge increased from 10 points in June to 14 points now.

The measures that helped the gauge were:
The measures that hurt the gauge were:
Taken together, the two inventory ratios are worrisome.

Growth. This gauge increased from 3 points in June to 7 points.

The measures that helped the gauge were:
  • CFO growth = 18.1 percent year-over-year, a major turn-around from last year's -33 percent.
  • Revenue growth = 4.0 percent year-over-year, tepid but a reversal from -6.1 percent.
  • Net Income growth = 3.5 percent year-over-year; also weak, but first positive income growth since Dec 2005.
The measures that hurt the gauge were:

Profitability. This gauge increased from 8 points in June to 13 points now.

The measures that helped the gauge were:
  • FCF/Equity = 17.7 percent, up from 11.8 percent in a year
  • Accrual Ratio = -1.9 percent, down (good) from +4 percent (reflects strong cash flow)
  • ROIC = 15.5 percent, good but down from 16.6 percent.
The measures that hurt the gauge were:
The big factor in the increase in operating expenses was the decrease in Gross Margin, which was only partially offset by reductions in other costs.

Value. Intel's stock price rose over the course of the quarter from $23.74 to $25.86. The Value gauge, based on the latter price, is now at 0 points. Why?
  • Enterprise Value/Cash Flow is 11.9, up from 11.2 in Sept 2006
  • P/E = 24.9, up from 20.0 (even though net income grew less than 5 percent over this period)
  • P/E to S&P 500 average P/E = 54 percent premium, compared to a 34 percent 5-year median premium
  • Price/Revenue ratio = 4.1, about the same as its long-term average.
The average P/E for the Semiconductor industry is a more expensive 28.5. The average Price/Sales for the Semiconductor industry is 5.3.

A very good operating quarter pushed the Overall gauge up from 20 to 30 points, an impressive move considering that the Value gauge made no contribution to the score. If the stock price were to dip, Intel attractiveness could increase substantially.

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