Name That Trade – $INTC: Chips and Dips

by Dan June 26, 2015 2:17 pm • Commentary

Back in late April I initiated a bearish position (read here) in Intel (INTC) shortly after their weak Q1 results and Q2 guidance, along with similar from Texas Instruments (TXN) and Qualcomm (QCOM), here was my rationale on April 24th:

The earnings moves in the group have been generally muted, largely the result of very low expectations, but there was one stock’s negative reaction to earnings that got me thinking about getting back on the short side in the space.  Yesterday Texas Instruments (TXN), declined 7% on a very modest earnings and sales miss, but fairly poor current quarter guidance.  TXN weakness is coming from the usual culprits, PCs and wireless infrastructure equipment, and obviously hurt by dollar strength.  I guess the main take-away is that of all of the stock’s that I expected to have large gaps lower on misses, TXN, who has lots of exposure to autos/industrials, which happen to be strong end markets, these guys were not on the radar.

Back to INTC. The company missed Q4 back in Jan and guided down Q1. Then in early March they pre-announced a worse than expected Q1, and then last week issued a slightly worse than expected Q2.  Expectations were very low to say the least heading into last week’s results, one reason for the stock’s initial 4% pop after earnings.  But the stock has since given back half of those gains. Aside from cheap valuation, 3% div yield and massive share buyback I see little reason to own the stock here.  And frankly, if the company disappoints on Q2 I could see investors losing patience as they wait for an upgrade cycle associated with Windows 10 from MSFT in Q4.

INTC is down a little more than 3% today in sympathy with Micron (MU) which is down 18% today on weak guidance given last night. Investors are likely preparing for weak second half guidance when INTC reports earnings on July 15th after the close.

On June 17th, on our sister site The Ticker District I debated my Fast Money co-panelist Tim Seymour on his bullish stance, and my bearish view, here were the highlights:

Bull – Tim:

I said I would own INTC here and stop myself out .50 lower with a “conservative” target to $37.00.  Dan said my conservative call was wrong and that he will wait until you see a test of $30.00 and this may happen in July with 3Q guidance.

My view is that $30.00 is a key level for the stock and I don’t want to be around for the gap through $30.00 if and when it happens.  My “.50 lower stop” is at $31.00 where there is most of the congestion on the recent one year chart.  Below $30.00 you gap to $26.00 then probably $23.00 so tactically if I’m playing INTC at these levels I’m playing because there is a very well defined support level. But I don’t want a wide leash.

Why do I want to own the stock in the first place?:

-It trades 20% cheap to big cap tech and recent revisions by the street are pricing in another weak 2Q.  This is where all the pressure on the stock has been of late – it’s in the price

-If you are focusing only on PCs you are missing the most important news out of INTC in years and that’s their Altera deal which alleviates reliance on PCs.  This deal is EPS accretive right now and provides for a chance at P/E expansion as the data center market grows.

Bear – Me:

1. Yes the stock is cheap, they are committed to capital return, with a dividend that yields 3%. But the company’s deal for ALTR, nearly $17 billion in cash is a substantial portion of the existing $20 billion on their balance sheet and from that will see their debt to equity ration rise dramatically as they tape the debt markets adding to their existing $13 billion.
2. It makes sense to fund accretive acquisitions with cheap cash, but they aren’t exactly buying rip roaring growth as both earnings and sales are expected to decline in 2015 for ALTR.  INTC CEO Brian Krzanich had the following to day about the deal’s rationale:

With this acquisition, we will harness the power of Moore’s Law to make the next generation of solutions not just better, but able to do more. Whether to enable new growth in the network, large cloud data centers or IoT segments, our customers expect better performance at lower costs. This is the promise of Moore’s Law and it’s the innovation enabled by Intel and Altera joining forces. We look forward to working with the talented team at Altera to deliver this value to our customers and stockholders.

3. Its my view the timing is not coincidental. A long time view at INTC is that they can spend themselves out of a recessions and downturns and that’s exactly what they seem to be doing here. But I wouldn’t expect anything positive in the near future, and possibly higher costs of integration and non quantifiable costs from a change of focus.  My sense is that Q2 was ok, the fact that they didn’t pre-announce it (remember they did negatively pre-announce Q1 on March 12th) means that they maybe pulled in some business to make Q2 and guide down Q3 or possibly the balance of the year.
In sum, cheap stock, trading below a market multiple. But for good reason given their cyclicality and the fact that a meaningful guide down could make the stock look expensive to peers, large cap tech and its historical average.  I don’t see a reason to step in before results in mid July, but could be intrigued if the stock sold off into the print as it could already incorporate what I think will be bad news.
So at this point, I want to remain long short dated puts.  The trade I have on is long July 30 puts that I legged into for 50 cents. offering a break-even down at $29.50, where the stock was trading before the late April ramp following the Altera take-over chatter.
A quick look at the one year chart and it becomes fairly apparent the stock is approaching a fairly key technical support level, and the formation over the last year looks like a TEXT BOOK head and shoulders top, with $30 serving as the neckline:
INTC 2 year chart from Bloomberg
INTC 2 year chart from Bloomberg

Given the move in MU today, and the weak results and poor price action from large cap tech companies Jabil and Oracle in the last week, I suspect that INTC could have an out-sized move if the company issues a miss and guide lower.

We have this trade on already (and are not adding to the position but I will be discussing this trade tonight on Options Action), but I like it more now than I did in late April.  For those who would look to play for a technical breakdown on poor fundamental news in INTC, targeting their Q2 report on July 15th, this is the way to do it now, in my opinion:

Trade: INTC ($31) Buy July 30 Put for 45 cents

Break-Even on July Expiration:

Profits: below $29.55

Losses: up to 45 cents between 29.55 and 30 with max loss of 45 cents above 30