At first glance, it’s easy to see why Microsoft and Intel gave the market a boost when they reported their latest results, since they all managed to beat Wall Street targets. So that’s it then — the tech sector is back on top, right? Back to the good old days of double-digit growth and beating estimates hands down. Except for one wrinkle: there is little fundamental growth at these companies, and their forecasts are underwhelming at best.
Intel’s sales and profit both topped estimates, but its revenue was $6.75-billion (U.S.), down 6 per cent sequentially and flat year-over-year. Net income of $915-million was down 13 per cent sequentially and down 2 per cent year-over-year. In almost every respect, from revenue and profit margin to net income and cost of sales, Intel’s numbers in the most recent quarter were virtually identical to the same quarter last year. In other words, no growth to speak of.
As for the current quarter, Intel referred to “continuing uncertainty in global economic conditions” and gave its target for revenue as between $6.4-billion and $7-billion. In other words, sales could rise 3.7 per cent or fall 5 per cent. What kind of forecast is that? One with lots of breathing room left in it, obviously. Gross margins for the second quarter are seen falling to 50 per cent from 52 per cent.
And what inspiring words did CFO Andy Bryant have? “We don’t see any sign of inventory build-up,” he said. “But it feels different. Does it feel like a recovery? No, but it feels modestly better. We actually feel a little bit more confident.” Hardly a victory cry, but that’s not surprising when you consider there is still no sign of a pickup in sales of PCs, the market Intel relies on for 80 per cent of sales.
Intel’s stock climbed by more than 5 per cent after it released its results, primarily because the market was expecting much worse. While many analysts applauded the performance, however, many warned about the future. “The economic picture looks increasingly clouded,” Peter Kastner of Aberdeen Group told CBS Marketwatch, “and they will have to be extremely adroit to pull off another good quarter in an otherwise lousy economic environment.”
Despite the fact that Intel has shown virtually no growth, its stock is up by more than 16 per cent this year, and sells for more than 30 times earnings per share. A.G. Edwards analyst Brett Miller wrote, “Until the bigger picture for corporate spending gets better, we believe it will be difficult for Intel to demonstrate growth that supports the 31-times estimated 2003 earnings multiple.”
As for Microsoft, the software giant’s revenue of $7.8-billion was up 8 per cent over the prior year’s quarter, and operating income rose by about 13 per cent. Net income, however, grew by just 1.8 per cent to $2.8-billion. In part, that’s because the company spent $5-billion buying its own stock –- to make up for the dilution from stock options –- and lost $7-billion on its investments. Of course, it still has more than $45-billion in cash and investments, roughly equivalent to the market capitalization of Canada’s two largest banks.
Saying it continues to “operate in a tough environment,” Microsoft cut its forecasts for the year to between $33-billion and $33.8-billion in revenue (below Wall Street forecasts of $34.8-billion) and profit of $1.04 to $1.06 a share, lower than the $1.08 most analysts had expected. Revenue for the current quarter is also forecast to come in below consensus estimates, while profit is expected to be flat over the latest quarter at about 23 cents a share.
“Given the uninspiring guidance, we continue to rate the shares of Microsoft a neutral as we believe the stock is currently only modestly undervalued,” said Merrill Lynch. Scotia Capital said “forecasting mid single-digit PC sales and continuing IT spend weakness until June 2004 at least… prohibits us from being more bullish on valuations,” while Soundview remains “concerned about growth catalysts” for this year and next, and said it believes “it is unlikely Microsoft will outperform the broader technology market.”
Some analysts give the company credit for continuing to grow its revenue and profits by moving into new markets such as game consoles and server software. Ironically, gross profit margins improved in part because its cost of sales dropped – and why did its cost of sales fall? In part because of lower Xbox sales. Since Microsoft loses money with every game console that it sells, the company’s bottom line actually improves the fewer units it ships.
The biggest problem that investors have to face is that the two largest players in the technology sector, the twin gods of the Wintel computer duopoly, can’t seem to see any external growth occurring in the PC sector for the foreseeable future. Intel’s target range suggests that there might be growth, or there might not –- or there might be the opposite of growth. Microsoft is growing, but warns that this will almost inevitably slow over the coming quarters.
That’s a tough recipe to build a rally on.
E-mail Mathew Ingram at mingram@globeandmail.ca
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