Cracks In My Belwether?

This was the week that, once again, Intel humbled the collective wisdom of the sell-side analytic community, with EPS a mere 33.3% higher than the consensus estimate. What Intel had to say also strengthened my sense that what we have here is going way beyond mere recovery (Web 2.0 definitely skipped a beat early last year, but quickly got right back on track) and even the rejuvenation of Intel itself (as described in Musings on 10/17/09, The Web 2.0 Belwether). I suspect it is more like evolutionary realignment, wherein pockets of relative rationality, niches (and so opportunities for sustained seasons of outsized profitability) in a relative if not quite absolute sense, seem to be emerging in what we call the Tech Sector. If so, the collective understanding (and so equity valuation) of the profitability of well-situated participants (high intellectual and capital barriers to entry in applications where the likes of Hitachi and Samsung can only be bit players, if they play at all) falls well short of reality. This earnings release caused INTC to trade up 3%+ after hours, and yet the next day INTC and the whole Market traded off in it worst day YTD. If ever there was a case study re the disconnect between Commercial Reality and Price Reality, we’re looking at it here.

The phenomenon of “buy the rumor, sell the news” is not lost on me, but this disconnect was striking enough to “play back the tape” and try and learn something. The idea that Intel is a great belwether for the global economy remains, to my mind, above reproach. You would think that the same might hold over in the realm of Price Reality. It is big, extensively followed, proactive in its investor relations and usually among the first major companies to report each Q. Its level and trend of its results are certainly more telling than Alcoa, which traditionally is first to report, but whose results are clouded by legacy operations and grossly subsidized overcapacity around the world. It was not as if INTC was racing up all week in anticipation, as if the Market “sensed” that the consensus was way too low. There were a couple of other factors that weighed on Friday (JPM acknowledging, to no one’s surprise, that commercial lending will be a long, slow recovery; Consumer Sentiment improving, but not as much as the geniuses had guessed it would), and one suspects that the sheer ghoulishness of Haiti put a damper on things. The prospect of a three day weekend probably had traders in a “sell and go away” mode. All this said, I was sufficiently perplexed to undertake an analysis of the price action of INTC since its nadir not quite a year ago. It turns out that the fits and starts with which INTC attempted to synch up with the rate at which the apparent Commercial Reality of Intel improved since the dark days of almost a year is quite instructive.

After printing a low of $12.06 on 11/21/08 (closing at $13.11), INTC hit its ultimate low of $12.05 on 2/23/09 (data is from Yahoo Historical Prices). It would print $12.07 on Friday 3/6, but its low on 3/9, the day the Market hit bottom, was $12.30. Seven trading sessions later it would trade as high as $15.41, a 25.3% advance off of the 3/9 low. Does anyone remember anything even remotely encouraging being said during those weeks? Neither do I. The stock would then drift for a very long time with only a faint upward bias. Q1 results had almost no effect on the price, which was almost the same a week after the report as it was a week before, though volume did spike and then remain well above what looks like depressed levels in the weeks leading up to that report. We seem to recall the CEO making comments about “a bottom”, but it sure was easy to be skeptical about what CEOs had to say back then. Although the stock managed to trade as high as $16.74 just before going ex-dividend in early May, it would manage to trade under $16 as late as 7/13. In the meantime, the recovery in the world of all things digital that the CEO was alluding to was coming to pass.

Q2 earnings were released after the close on 7/14 and woke the world up to this seeming step-change in economic reality. INTC close up $1.22 the next at $18.05. It would ride the wave of Market enthusiasm which it had unleashed over the next two weeks, trading as high as $19.80 on 7/30. This level would not be surpassed until the company decided, on 8/28, to help Price Reality along by issuing an announcement that Q3 sales and earnings were on track to be higher than previously expected. This announcement gunned the stock a whopping $0.78, to $20.65. On 9/9, six months since the 3/9 nadir, INTC closed at $19.93. Notice that just how much of the $7.62, or 62%, price improvement over the course of six months took place in two short bursts: seven trading days following 3/9 (25%+) and a dozen or so days following the earnings surprise that surprised in a sense more profound than just beating consensus (18%+).

The excitement generated on 8/28 would quickly die down, and despite an unrelenting cascade of indications that the PC world was not only recovering but shaping up for boom times, INTC continued to more or less mark time. Here is an enterprise with incalculable barriers to entry, singularly well positioned to meet a need that is growing in way that, a few months earlier, was beyond anyone’s wildest imagination, and with extraordinary financial flexibility as well, but most of the time it trades along like a tired old rust bucket cyclical. It did not reach the 8/28 high ($20.65) until 10/12. Q3 earnings would follow on 10/14, and despite the pre announcement of 8/28 consensus was still way too low. Despite this powerful earnings performance and a robust outlook, the next day the stock managed to trade as much as $0.75 higher, to $21.76, before closing up only $0.34 for the day. From there, it would dribble lower against a backdrop of burgeoning prospects for the markets it serves, ultimately printing a low of $18.31 on 11/03. Thereafter, the stock would drift higher, but have a hard time breaching $20 until very late in the year, when it became apparent that the PC supply chain, which normally starts to slow down production in December, was running hard to keep up with the rejuvenated demand.

Viewed in the light cast by the Q3 experience, the underwhelming response to the Q4 results and confirmation, in my estimation, that Intel has arrived at a disposition that is more favorable than any of us can remember should not be so surprising. Even with well-known, rigorously followed and very much in control of their destiny enterprises like Intel, market “efficiency” is a curious thing. The past year does not depict a compelling case for the idea that the Market anticipates in the vein of “buy the rumor, sell the news”. Perhaps there is a technological threat that I am simply too dense to see, like phone chips actually supplanting the work that Core processors practically own, as opposed to merely sharing in the growth at the margins and so “taking share” of a burgeoning pie. If so, we will know in another year or so. More likely, the Market is just about as wrong pricing INTC at $20.75 as it was pricing it at $70+ a decade ago. (Are “these guys” any smarter than “those guys”? No wait, a lot of them are the same guys!) With a little over $2 per share in net cash (and more than they need rolling in every day) a company with Intel’s prospects ($2 EPS in 2011 is not unthinkable) should not have price that starts with a “2”. Chalk it up to that which is the nexus of investment opportunity, the persistent disconnect between Commercial Reality and Price Reality.