$INTC Inside $SMH

by Dan April 19, 2016 1:30 pm • Commentary• Trade Updates

Event: Intel (INTC) reports Q1 earnings tonight after the close. The options market is implying about a 4% one day post earnings move tomorrow, which is inline with the 4 qtr avg one day move, and mildly rich to the 10 year avg of about 3.75%.

Following INTC’s Q4 results in mid January, the stock declined 9% the next day, largely from management’s commentary on their earnings call (emphasis mine):

Brian Krzanich CEO
Wrapping up, our results over the last year leave me increasingly confident in our strategy. While our outlook for the first quarter reflects some caution about overall demand, particularly in China, we continue to expect solid growth in the business in 2016.

Stacy Smith CFO
For the first quarter of 2016, the mid-point of the revenue range is expected to be $14.1 billion. This forecast, which includes an extra work week and the newly acquired FPGA business, is on the low-end of the average seasonal range. This outlook represents a soft start to the year as we remain cautious on the level of economic growth, particularly in China.

Brian Krzanich CEO
It is the same type of trend we saw in 2015, emerging markets slower than the mature markets, U.S., Western Europe looking okay. China and the rest of Asia, slow. It was both, consumer and enterprise.

Stacy Smith CFO
Then our team on the ground in China has gotten fairly cautious about what is going on in China right now. As you know, that is the largest PC market, so we are just little cautious on the growth rates there.

DOLLAR: Since January 14th when the company last spoke to investors there fears about a hard landing in China has abated, the U.S. dollar (DXY) has weakened by 5%, which could be a significant tailwind given the fact that more than 70% of their sales are booked outside the U.S.

PCs: One thing that has not changed since January, is that PC sales continue their decline, as Gartner recently reported that the yoy decline in Q1 was 9.6% to below 65 million units for the first time since 2007.

HEADWINDS: I would add that the reprieve from the weak dollar could not have come at a better time for Intel when you consider the weak commentary from the PC supply chain of late, Seagate & Juniper in the last week speaking to weak enterprise demand, Taiwan Semiconductor last week suggesting the high end of the Smartphone market is weak and Micron a couple weeks ago pointing to weak memory demand.  The question investors have to ask themselves is whether or not the recent dollar tailwind will offset weak seasonality and ever prevalent secular headwinds?

VALUATION/BALANCE SHEET: And there is always the argument to be made that INTC trades 13x 2016 eps, below a market multiple, has a multi-billion share buyback in place, pays a dividend that yields 3.3%, nearly 2x that of the 10 U.S. year treasury yield and potential added cost savings from their recently closed acquisition of Altera.  The stock is cheap, has a strong  balance sheet, near monopoly in PC and Server chips and decently positioned to grow in mobile.

Price Action / Technicals: The stock is down 9% on the year, up 13% from its February lows (basically in line with the SPX) and up 26% from its August 2015 flash crash low.

The way I draw the lines from the 5 year high in early 2015, and the five year low in late 2012 suggest that the stock could be at a near term inflection point with a failure here causing the stock to re-test the high $20s, and a breakout here leading to a re-test of $35:

From Bloomberg
From Bloomberg

On a shorter term basis, the stock is trading at just about the mid point of support just below $28 and resistance at the one year high just below $36:

From Bloomberg
From Bloomberg

Options SnapShot: When you look at the price of short dated options prices relative to recent movement, implied volatility (blue below), while below levels from the last few quarters, is fair vs realized volatility (how much the stock has been moving, white below). That means the implied move is potentially cheap if realized were to pick up:

from Bloomberg
from Bloomberg


For the time being, the stock is a value trap. I suspect the secular shift away from PCs, INTC’s so so positioning in mobile, the potential hiccups of integrating ALTR, uncertain growth in China, and the current headwinds for servers with weak enterprise demand could cause one more guide lower for INTC causing the stock to test the lower band of the one year chart.  I’d be a buyer of the stock the mid to high $20s though.

So what’s the trade?

We’d prefer not trade INTC in front of earnings as it could be a binary event, but as we outlined last week in a post on the SMH (semiconductor etf, read here):

for those looking to play the sector directionally or those looking for some cheap portfolio protection, the options are both dollar and vol cheap.

We think an SMH short is probably a better way to play for continued disappointment in the sector. remembering that INTC is the largest holding in the SMH at 13.7%.

*Buy the SMH (54.10) May/Aug 52 put calendar for 1.30
  • Sell to open 1 May 52 put at .55
  • Buy to open 1 Aug 52 put for 1.85

Rationale – This trade targets a pullback in shares to the $52 area over the next several weeks. (which includes reports by INTC and QCOM). It then leaves us the optionality to stay in the trade for further weakness over the Summer by either rolling the short put to June and then July or simply spreading in August, creating a vertical. If we get some relief rallying near term on earnings the short May put should help the trade from becoming a big loser and would become worthless pretty quickly. If the index goes sideways we’ll be in good shape. And a move to 52 before May expiration is ideal. That also happens to be the converging 50 and 200 day moving averages and why we chose that level to target:

[caption id="attachment_62968" align="aligncenter" width="644"]sg2016041946887 from Bloomberg[/caption]