Intel downgrade pegged to PC sales slowdown

The reasons for the downgrade from U.S. Bancorp Piper Jaffray analyst Ashok Kumar could mean slower-than-expected sales for virtually every PC manufacturer in the second half. His bleak forecast could mean trouble not just for Intel but also for rival chipmaker AMD and major PC makers such as Compaq Computer, Dell Computer and Gateway.

Kumar's downgrade, to "buy" from "strong buy," sent Intel shares tumbling 6.3 percent to $69.25 at the close of regular trading and pulled down major PC maker shares in the process. Dell and Gateway both fell more than 5 percent.

"We expect sequential (PC) growth in the September quarter to come in at about half the level of what the Street expects," Kumar said. "Street expectations are about a 12 percent sequential unit growth, and we think best-case scenario growth will be about half that.

"There could be further erosion to those numbers," Kumar added, "if the business does not pick up materially in the next three weeks." He predicted that virtually all the major PC makers would miss expectations for the third quarter. "So the PC market has essentially peaked."

Other industry analysts did not share Kumar's level of pessimism.

"I would say is it's an overreaction," International Data Corp. analyst Roger Kay said. "Our forecast is for the third and fourth quarters to be up after a rough first half.

IDC forecasts sequential PC growth of 13.4 percent in the U.S. and 10.1 percent worldwide for the third quarter. Fourth-quarter sequential growth is projected at 13.1 percent here and 21 percent worldwide.

Dataquest puts year-over-year PC growth at about 12 percent for the first half, 15 percent for the second half and 14 percent for the year.

"I don't think this is as alarming a figure compared to (Kumar's) numbers," Dataquest analyst Charles Smulders said.

But Smulders does see an overall weakened market, but not as weak as Kumar's scenario.

"The underlining issue here we continue to be alarmed about is the (PC) saturation in large accounts and the home market," he said. "And these issues will certainly come to bear on growth."

Kumar's action is the first significant analyst downgrade to hit the stock since May. Prudential Securites analyst Hans C. Mosemann reiterated his "strong buy" rating on Intel on Aug. 24; ABN Amro analyst David Wu reiterated his "outperform" the same day; and Lehman Brothers analyst Dan Niles reiterated his "buy" rating on Aug. 21.

The bleak forecast stems from signs of rapidly slowing demand at a time PC sales should be picking up, Kumar said.

"Second half represents about 55 percent of the unit shipments. The fact the sell-through is not materializing is even more concerning," he said.

With the exception of Japan, Kumar forecasts slower demand in nearly every geographic region. The Asia-Pacific, which accounts for nearly a third of unit shipments, will have the slowest growth rate, he predicted. Europe is expected to drop into the single digits from about 16 percent in the first half. Growth rates in North America also will fall into the single digits, he said.

"Q3 is usually seasonally strong, so this scenario is onerous for the remainder of the year," Kumar said "The industry isn't a build-to-order industry; it's a build-to-forecast. That means serious inventory shelf hangs, which have a shelf life of a sushi plate. So the pricing environment can quickly turn malignant."

With Intel and PC manufacturers planning on strong demand, the unexpected downfall in growth could lead to a supply glut and price war among computer makers.

Compaq's recent second-quarter crisis in consumer sales could foreshadow what other PC makers may face going into the holiday buying season. An unexpected sales drop in May hit Compaq hard. Though the company's consumer group had year-over-year growth of 39 percent in April, it fell in May to 4.2 percent before rebounding to 35.4 percent in June.

Other companies faced similar problems and cut prices, like Compaq, to clear out excess inventory and remain competitive. That action, among other factors, throttled down Compaq's consumer group operating margins to 1.9 percent from about 4.5 percent a quarter earlier.

The sales slowdown Kumar forecasts is further exacerbated by an expected second-half increase in Windows 2000 systems and licenses failing to materialize.

Many analysts predicted a surge in commercial PC sales following Microsoft's release of the first collection of bug fixes--or service pack--for Windows 2000. Gartner, International Data Corp. and many other market research companies recommended that many corporations wait until after the release of Windows 2000 Service Pack 1 before moving to the operating system.

"The release of Windows 2000 Service Pack 1 has done nothing to resuscitate commercial sales," Kumar said.

"If you use the Windows 2000 service pack as a point event and say there is no rush orders of Service Pack 1, you're missing the point about Windows 2000 deployment," Kay said. "I don't think a service pack is going to make a difference, because many people have already made their plans and are rolling out Windows 2000 on an going basis."

The scenario is perhaps bleakest for Intel, which has battled numerous supply problems. Last week, the company recalled the 1.13-GHz Pentium III processor, and it faces a potential glut of chips as PC sales growth tanks, Kumar said.

The analyst also expressed reservations that the chipmaker could produce high-enough yields of gigahertz processors and questioned the company's capacity to deliver enough Pentium 4 processors during the first half 2001.

Given Intel's weakening fundamentals and the PC sales slowdown, he predicted the stock would pull back to its base of $60.