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Naveen Selvaraj
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Naveen Selvaraj is a sector specialist with strong expertise in the Technology, Telecom and REITS sectors.
My blog:
gridstoneresearch.com
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  • Intel's Record Gross Margins: 2010 Can Be Even Better
    Intel(Nasdaq:INTC) reported results for QEDec09 and FY09 last week and the "record" gross margins were discussed quite keenly in the earnings call( Read transcript here) and in many post-earnings result reviews.

    While Q4 gross margins of 65% was way above margins achieved in any of the previous fiscals or quarters, the fiscal 2009 margins of 56% were well within the historical range. Therefore the record gross margins have been to seen in this context as Intel typically has higher sales and higher gross margins in the last quarter of any fiscal due to seasonality.


    Source: Gridstone Research

    Even then, the 65% gross margin is a clear 20 percentage points above the gross margins in Mar09 quarter and 12 percentage points above the 53% achieved in Dec08 quarter and this huge improvement is more to do with the recovery being much much faster than expected and Intel taking aggressive actions in the first of 2009 to rein in costs.  This goes to show how much an increase in revenue and tight controls in spending have boosted margins for Intel. Add a lack of competition to that!!

    Source: Gridstone Research

    With Intel guiding for ~61% gross margin in 2010(mid-point of 58-64% range),  a repeat of the stellar margins in the fourth quarter of 2010 is definitely possible. Here's why:



    Source: Gridstone Research

    Fixed assets turnover( Rev $ divided by Net PP&E) is an important metric and indicator of gross margins for semiconductor companies(which also have their own fabrication units). Intel achieved a fixed assets turnover of 2.45 in Dec09 quarter. This means that for every 1$ of productive assets it holds in its balance sheet, it generated $2.45 in annualized revenues in Dec09 quarter which is above the earlier peak achieved of 2.36 in 2005(on a fiscal basis). So Intel extracted more revenue dollars from its assets in the Dec09 quarter than it has ever done earlier but on a annual basis, it still achieved a asset turnover of 2.02 only, well below the historical peak.

    The main reason for this 'record' asset turnover in Dec09 quarter is that revenues surprised on the upside and Intel also spent lesser than expected on capital equipment. Here's Intel CFO's comments from  the earnings call:

    "...As a result of capital reuse and achieving efficiencies we were able to ramp 32 nm process technology and still bring down our capital forecast from our expectation at the beginning of the year. Our capital purchases for the year of $4.5 billion is down from our original forecast of around $5.2 billion and was less than the annual depreciation run rate. Operating expenses remain in tight control. "

    This means that if Intel is able to achieve a asset turnover higher than the 2.02 achieved in fiscal 2009, the gross margins in fiscal 2010 would be higher than 2009 as long as revenues are higher and capacity additions don't affect the margins.

    Intel has guided for ~$4.8B in capital spending in 2010, just $400M above the annual depreciation guidance of $4.4B for 2010.  It is unlikely that Intel will incur any incremental under-utilization charges(of capacity) as the capex additions just about covers for depreciation and a small increase in capacity to support volume growth. Intel is effectively guiding for ~14% revenue growth in 2010 as the  simple calculation below shows:

    Gross margin(GM) guidance for 2010 : ~61%
    Gross profits at 10% revenue growth, flat capacity costs: ~23B(on revs of $38.6) giving GM of 59.6% which is well below guidance
    Gross Profits at 14% revenue growth, flat capacity costs:~$24.4B(on revs of $40B) giving GM of 61% which comes to around the guided mid-point of range.

    We see that at ~14% revenue growth, Intel will achieve a gross margin of ~61% as long as additional capacity costs are not incurred. The 14% revenue growth is higher than the 10.2% growth forecast for semiconductor sales by SIA(Source:SIA PR dt.Nov5,09) but with Intel's increasing lead over AMD and the expected pick-up in PC processor demand, the 14% growth looks realistic. Also at sales of $40B, the asset turnover will be 2.27(40/17.6) which is well below the peak achieved. So clearly with this level of capital spending and revenue growth, fiscal 2010 gross margins of 61% are achievable. Any further upside in revenue growth will boost margins to that extent as there could still be some leeway for improving capital equipment efficiency(remember the peak achieved is 2.36)

    In summary, the 'record' gross margins of Dec09 can be beaten in Dec10 quarter as all the factors in favor of better gross margins are in place: Double digit revenue growth, no increase in capacity costs and lower inventory. The only way margins are going to be lower is due to intense competition for Intel in the processor space and that seems unlikely, atleast in 2010.










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    Jan 18 4:30 AM | Link | Comment!
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