Intel and AMD: Do The Margins Really Reflect the Risks?

Includes: AMD, INTC
by: William Trent, CFA

Doug McIntyre at 24/7 Wall St. noted that Intel (NASDAQ:INTC) in its annual report, and AMD (NASDAQ:AMD) both claim that the next few quarters would be good: Why? Because the two companies represent virtually 100% of the processor market for PCs it would be hard for both companies to be right.

While Eric Savitz passed on Citigroup’s guess that Intel would consolidate share, the first question that came to my mind was that, based on the inventory and gross margin studies I have been doing, whether it even matters.

Starting with the actual inventory levels, measured in days sales on hand, Intel has 87.4 days while AMD has 67.8. While the company level inventory could mask trends going on in the channel (such as Hewlett Packard’s (NYSE:HPQ) in its Annual Report, "strategic buys"), it does potentially indicate that AMD have less need to discount inventory in the near future, and potentially better margins.

Moving along to the trends in inventory management, when compared to the year-ago levels, Intel’s DSI have risen 12% compared to a 13% decline for AMD. However, on a sequential basis both companies are moving closer to even with last year. That is to say, the trends are toward mean reversion. Since the picture is mixed, I hesitate to draw conclusions regarding margins from this comparison.

Comparing the amount each company produces to the amount it sells, I found that AMD has been producing significantly more than it is selling for the last four quarters, while Intel’s production has been in line with demand for the last three quarters. This contrasts with the actual DSI study, and checking back to the original data it looks to me like the smoothing process (I calculated DSI as the 4-quarter sum of COGS using the 5-quarter average of Inventory), masked the more recent inventory build. Therefore, on balance the data indicates that AMD has more risk to future margins than Intel.

Interestingly, AMD has already seen a far more significant margin decline (see charts below).

AMD Margins
AMD Margins

Intel Margins
Intel Margins

Since I don’t have access to gross margin estimates, it is hard to tell whether the potential margin pressure is factored in to current estimates. Estimates have been falling for both companies over the last 90 days, and far more so for AMD, suggesting that at least some of the differential is expected. However, the estimates also imply improving margins for both companies in the September quarter compared with the June quarter, in part due to higher expected sales leading up to the seasonally strong part of the year.

If Citigroup (NYSE:C) is right about AMD’s product delays, I would argue that it does matter, and that there is even more risk to AMD’s margins than is currently reflected in estimates.