Making sense of INTC's 2Q11: PCs down, capex up

Intel handily beat expectations for its 2Q11; PR here, analysis is all over the Web. Besides the general number-crunching, here are two key themes relevant to our semiconductor manufacturing audience:

- PC growth lower. Sales in INTC's PC group rose 11%, despite general malaise reflected by other industry watchers -- and indeed INTC now is cutting its PC growth expectations to ~8%-10%, though sales will still be higher thanks to "a very rich mix" of enterprise PCs, noted CEO Paul Otellini in the financials conference call. INTC also continues to see above-average growth in emerging markets, e.g. India, Russia, China, and Latin America (Brazil will likely be the third-largest PC market in 2012) all showed PC shipment growth in the mid-teens during the quarter.

Otellini also reiterated his view that PCs aren't really threatened by tablets, but the new devices are actually "additive to computing" as "a companion device" and won't replace PCs, though netbooks are showing signs of being affected. (Also note that INTC's PC forecast, while lowered, is still higher than the single-digit growth -- if any at all -- professed by other industry watchers.)

- Capex budget higher. Most relevant to our semiconductor industry were the comments about INTC's hiked capex budget for 2011, and how most of that is going into factory-building, noted CFO Stacy Smith. "It's been a long time since we've had to build incremental shelves, but the growth in our business now requires it," he said. "So we're putting in place some clean room space that we haven't had to do over the last couple of generations."

Often when a company raises numbers in the short-term, it's just pulling them in from future plans -- and some of this increased 2011 capex is just that, Smith acknowledged on the call. "We're going a little faster on the 40nm factories," where the company "saw some opportunities to do some things in the infrastructure" to be able to incorporate post-40nm work, even down to 10nm and 7nm, he said. "It gets kind of high ROI to do that now versus having to retrofit those factories later."

Smith also hinted that 2012 capex will increase again, reiterating that INTC's capacity spend tends to be "a couple years cycle". "Expect elevated capex next year relative to the historical trend line," he said, but without specifically committing to a figure. (Later in the call, Smith noted that the capacity going in can be throttled back "if things end up being softer" than anticipated unit growth, much like the company did in 2009.) (Deutsche Bank's Ross Seymore pegs INTC's 2012 capex at $8B, down -20% from 2011 and ~14% of sales.)

Some other points to ponder about capex, courtesy of Credit Suisse's Satya Kumar:

• In 1H11 INTC spent just a hair under 50% of its total 2011 capex budget, implying neither frontend- nor backend-loaded spending. Given negativity swirling about 2Q-3Q semicap equipment orders, that linearity probably a good thing, especially for companies with INTC exposure.
• From a macro perspective, note that it's the foundries who have been generally understood to have overextended and now cutting back their spending, and that sector (as well as Samsung) has yet to be heard.
• INTC's capex is being raised, even as its PC unit shipment growth is lowered.

Getting bearish: Analyst cut back 2011 SCE, but improve 2012

A handful of industry watchers are lowering their 2011 outlooks for semiconductor capital spending, betting that there's more bad news ahead -- but 2012 might not be as bad as feared.

The bad news? SCE orders, which have been on a downward slide, now likely won't get better (and probably will get worse) through 3Q11, and 2011 looks a little less rosy than before. The good news: many think 2012 might not be as rough as feared, so the expected Y/Y dropoff may not be as painful.

Credit Suisse's Satya Kumar is lowering his expectations for capex, wafer starts, and some memory themes, citing elevating chip inventories, still-sluggish consumer PC demand, and some non-Apple tablet vendors cutting component orders.

For capex, Kumar is lowering his 2011 outlook for semiconductor capital equipment to 9% growth (vs. 15%) to $55.2B, but raising it for 2012 to flat growth/$55.1B (vs. a -9% slide). More granularly, he sees SCE orders down about -20% sequentially in 2Q11, and 3Q11 orders flat to down -10%. "SCE companies have been talking about order pushouts since April," he explains, and "the order and capex environment has not improved through June."

Kumar is still bullish on rising capital intensity in semiconductor manufacturing. PC and tablet sell-through is still up 15% in 2011 (smartphones up 50%), he notes, so the issue is not so much weak consumer demand -- it's rethinking expectations about supply chain normalization vs. sell-through, he says.

Other analysts are also lowering their 2011 outlooks. Days ago, Barclays' CJ Muse likewise lowered his take on semiconductor equipment spending, recasting his 2012 outlook to $48.5B (a -10% decline vs. a flat/-10% range). His main concern is foundries which could slash spending by -20% next year; NAND makers will cut back to flat or -10% too, and there'll be a -15% decline in logic led by a -22% dropoff at Intel, he warns.

Also in the past week, Needham analyst Edwin Mok cut his semi capex estimates for both 2011 ($56.1B vs. $59.2B) and 2012 ($56.9B, ekeing 1% growth), citing pushouts by Samsung and TSMC that have dented 2Q11 orders by -10% to -25% -- and he thinks there will be more bad news coming in the current quarter (3Q11), with sales possibly flat or even down another -10% (overall Street is expecting -2%). While some of the pushed-out orders have returned [e.g. Samsung for NAND], we believe TSMC has put its Fab 14 expansion on hold," Mok writes.

And RBC Capital's Mahesh Sanganeria has reduced his outlook for semiconductor capital spending to 4% in 2011 instead of 11% (though improving 2012 to a -9% decline instead of -17%). TSMC orders have helped give a brighter picture, but now the foundry seems "caught up after underinvesting" and since April has pulled in the reins "significantly," he writes.

Overall the new outlooks have several things in common:

- More bad news in 3Q11, but probably a trough for overall SCE orders, and for front-end tool shipments.

- For sector stocks, valuations are really low -- as in low-teens or even single-digit multiples vs. 2011 expected earnings (though of course earnings outlooks change quarterly), and in the mid-teens vs. S&P multiple. Many chip equipment stocks have been taking a beating, down 10%-20% or more in 2Q11, most likely as investors gird up for anticipated lean times ahead for the industry -- so the analyst bears' partial forecast improvements for 2012 could be a welcome sign.