Despite strong second quarter 2011 revenues of $13.1 billion, Intel (INTC) reported gross margins of 61.9%, a decline of 5.5 points from the 67.4% realized in last year’s Q2.
We should note that sales were up a smart 22% from last year’s levels, due in large part to demand for Sandy Bridge products. Although the acquisitions of McAfee and the Infineon wireless division are still being digested, we have a very high opinion of Intel and its management team.
That said, we believe there were ample clues in the company’s financial statements which might have provided investors sufficient information to take profits prior to the share price decline leading into Q2 2011 earnings.
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Earnings Quality
The first noticeable change in INTC’s earnings quality can be seen in the precipitous decline in the dual cash-flow ratio as displayed in the Merriam Report model. Notice that after peaking near +15 in Q4, the March 2011 Q1 reading fell some 45% to +8.021.
Contributing factors to the decline appear to be related to a 23.5% spike in accounts receivable during Q1. This pushed days-sales-outstanding to a record high of 21.5 days for the period and the highest of the seven quarters reviewed.
We also note that accounts payable grew 20.4% over the previous period and this marks the highest rise in payables growth in our seven quarter review.
Cash-Flow
Our model looks at cash-flow a bit differently than more traditional methodologies in that we separate “cash” generated from actual operations and “cash” derived from balance sheet maneuvers. The result of this generates our dual cash flow indicator (below).
Although INTC generates significant operating cash-flows, balance sheet cash-flows as a percentage of sales, increased to 67.9% of sales in the recent quarter versus 48% of sales in the prior fourth quarter. With over $11 billion in cash investments, INTC is not at all facing any sort of liquidity problem, but it is taking longer for customers to pay in recent quarters.
Accruals
We do note a significant improvement in INTC’s accrual ratio trend in recent quarters (see lower right chart above). This is an interesting contrast to the declines seen in the Q1 dual cash indicators, but the fact that Q1 2011’s ratio figure turned negative leads us to believe that the company is not going out of its way to exaggerate messy non-cash adjustments.
Revenue Metrics and Capital Productivity
The most obvious indication that gross margins would likely be impacted going into the second quarter report can be seen in the Q1 changes; falling R&D, rising cost-of-sales, rising accounts payable.
Offsetting this was a significant decline in S/G/A expenses during the latest quarter.
With regards to capital productivity (per $1 of sales), inventory and receivables costs rose, offset by better utilization of property, plant and equipment.
Summary
Product mix within emerging markets, enterprise (within both server and client markets) appears to be holding up well. Weakness in mature market consumer segments may continue to be a drag on earnings in the near-term.
Absent current available information for the Q2 statement of cash flow, we put INTC’s estimated fair-value at about $18 a share. Based on Friday’s close of $22.81, the stock looks to be approximately 27% over-valued to our estimated fair value.
Traders might find opportunities in the $21.50 area and longer-term investors may want to consider partial positions at $21 and full positions up to $20.
You can view our complete report for Intel here.
Sources: MerriamReport.com, CNBC, SEC (Edgar)
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
