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Posted 7/19/2004
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Contrarian Chronicles
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Intel's twin woes: excess capacity, slack demand
Chip giant's results expose huge problems the whole industry faces -- too much stuff and too few buyers. Expect poorer results going forward.
By Bill Fleckenstein
"Swimming in excess capacity" is the theme of this week's column. Intel (INTC, news, msgs) hammered that home, on the back of last week's news that its inventory is bulging. The problem facing Intel, which is common to many chip and non-chip companies, is that there's simply too much capacity. Right now, worldwide annual PC sales are about $180 billion. PC makers sold between $150 billion to $200 billion worth of PCs for the last five-plus years. As you can see, the PC market has stagnated in dollar terms, though it has had its ups and downs.
As the bubble passed through its initial stages of bursting, as the stock market went down and as the economy tanked, Intel decided it would grow its way out of its problem by continuing to add capacity. What's clear now is that the company's growing inventory is a function of the fact that it has too much capacity for an end market that is not growing.
Last Tuesday, Intel guided slightly higher in expectations for this quarter, to close to $9 billion in revenues. I believe the only reason Intel did this was that it had to -- as the only way to justify its out-of-control inventory situation. In any case, there's virtually no chance of Intel hitting that number. For Intel to manage to unload all the product currently being made and clean out the inventory, it would need sales of about $12 billion. That is definitely a bridge too far.
A rueful recipe: surplus plus slack demand
Intel is now trapped. To repeat, it has bulging inventories (which I wouldn't be surprised to see grow again in the third quarter) and too much capacity. The company basically overspent relative to the saturated market it sells into.
Parenthetically, I note that a dead-fish analyst associated with the House of Thundering Hooves is no longer clueless about Intel's inventory problem. Last Monday, he downgraded the stock. Apparently, he stumbled onto a story that will sound relatively familiar to Contrarian readers. (See Is Seagate's swoon bad for Intel, and more recent comments in Stagflation, anyone? The slowdown has begun.)
In any event, if demand slows as I suspect it will, Intel would have to cut prices to move inventory, and at some point would probably need to cut production. (Its midquarter update in September looks to be D-Day for the company.) That will affect its stock price and the psychology in the chip sector generally.
Away from Intel, other chip companies face a similar situation because of the saturation in so many markets, the excess capacity and of course the mounds of inventory. Witness what we've seen on the balance sheets of so many chip-oriented companies. This also has ramifications for semiconductor-equipment companies, which have benefited by the continued buildup of excess capacity.
It's worth noting that what I've presented regarding the chip sector is a microcosm of the excess manufacturing capacity overall that was slapped together during the bubble. It has never been completely rationalized, as folks continue to hope things will get better and continue to speculate, using their houses as ATMs.
Intel may be an extreme example of a misallocation of capital, and it's certainly not applicable to all businesses in all industries. But it is generically the problem that we face: The residue of the giant misallocation of the bubble and people's belief that those were normal times, rather than the once-in-two-generations period that it really was.
Micron spins an outlook yarn
Finally, in the department of wishful thinking: Micron Technology's (MU, news, msgs) VP of Worldwide Sales, Mike Sadler, announced last Tuesday, "We're expecting a stronger fiscal fourth quarter than fiscal third quarter because we will have pretty significant output increases . . . (read: Micron is going to make more parts), and as long as (my emphasis) we sell all the production output, it should result in stronger fourth-quarter earnings."
In other words, Micron's going to make a whole bunch more stuff, and as long as pricing holds, and if Micron can sell it, things will be wonderful. This is basically what it's said every quarter for the last five or six years, and things haven't worked out. Of course, Micron has no idea what end demand will be like, since its position is at the back of the food chain.
Nobody's fool on back-to-school
Meanwhile, as if that comment by Sadler weren't absurd enough, the next day he said that back-to-school demand is going to be pushed out a month. Now ladies and gentlemen, are any of your children going to school a month later than planned? I didn't think so. What this tells you is that so far, Micron's order demand for late June or early July has been anemic, and that's quite likely what Intel was seeing as well.
Obviously, whatever was supposed to happen regarding the fabled back-to-school build is not happening. Whether it's completely and totally due to PC saturation, a function of the post-stimulus slowdown or some combination of the two, I don't know. But suffice to say, the PC/chip sector is going to be under pressure for the next couple quarters, at a minimum. I wouldn't be a bit surprised to see either Dell (DELL, news, msgs) or Hewlett-Packard (HPQ, news, msgs) have to acknowledge that in the not-too-distant future.
For chip companies to continually contend that they'll keep making parts, and if things get better they'll do better, is a little bit like saying: If I could fly, I wouldn't need a car.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckensteincapital.com site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. At the time of publication, Bill Fleckenstein held these positions on stocks mentioned in this column: Short Dell, long Dell puts, short Hewlett-Packard, short Intel, long Intel puts and short Micron. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money.
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