Inside Intel (INTC) Q3 Earnings

by riskreversal October 18, 2016 1:48 pm • Trade Ideas

Event: Intel (INTC) reports Q3 results after the close. The options market is implying about 3.25% one day post earnings move which is shy of the 4 quarter average one day post earnings move of 4.2%, and slightly below the 10 year average of 3.74%.  With the stock near $38, the Oct 21st weekly 38 straddle (the call premium + the put premium) is offered at $1.25, if you bought that, and thus the implied move between now and Friday’s close (much of which is the earnings move) you would need a rally above $39.25 or a decline below $36.75 to make money.

One reason for the implied move being below the short and long term average is because the company already pre-announced better than expected Q3 sales and margins on Sept 16th:

revenue is expected to be above the company’s previous outlook. The company now expects third-quarter revenue to be $15.6 billion, plus or minus $300 million, as compared to the previous range of $14.9 billion, plus or minus $500 million. The increase in revenue is primarily driven by replenishment of PC supply chain inventory. The company is also seeing some signs of improving PC demand.

The company is forecasting the mid-point of the third-quarter GAAP gross margin range at 62 percent, plus or minus a couple of points, up 2 points versus the prior third-quarter GAAP outlook gross margin midpoint of 60 percent, driven mostly by higher PC unit volume.

Since the pre-announcement INTC is up 4%, only 1% from its 52 week highs made on Oct 10th. Some might look at the chart since the start of 2015, up just 3%, about in line with the performance for the S&P 500 (SPX), but under-performing the Nasdaq Composite (CCMP) and suggest the stock is about to wake from its long dirt-nap:

INTC since Jan 2015 from Bloomberg
INTC since Jan 2015 from Bloomberg

Taking a longer time horizon, the stock is at near and long term technical resistance with essentially no upside resistance above:

INTC since 1999 from Bloomberg
INTC since 1999 from Bloomberg

This morning Barron’s Online Tech Trader Blog highlighted a bullish call from Barclay’s Semi analyst Blayne Curtis on INTC, upgrading the stock to a Buy with a $45 12 month price target:

He thinks Intel is poised to see faster revenue growth as PCs become a smaller and smaller part of the business, and the company doesn’t get enough credit for data center and related trends:

While the improving PC market is certainly a factor in this move, Client Compute Group (CCG – PCs and Mobile) are a shrinking part of the INTC story with every passing year and we are rapidly nearing a point next year where the company’s non-PC businesses are a majority of overall revenue. Data Center Group (DCG – Servers) at nearly 1/3 of total revenue is now large enough that even with some haircut to INTC’s LT mid-teens growth forecast it can drive above market growth for the company as a whole, particularly if declines in the PC business have moderated. We believe this trend is already well underway and highlight that excluding the ALTR acquisition, INTC revenue is on track to grow ~4% organically this year and should accelerate as PCs decline as a portion of the overall mix. We also highlight that while peers like NVDA (28x fwd P/E) get ample credit for exposure to trends like deep learning, big data, and autonomous driving, INTC (>14x Fwd P/E) is also poised to benefit from these markets as the dominant player in the datacenter market.

Intel may also benefit as chip investors rotate out of current favorites:

More broadly, this year has seen a strong rotation into large cap semi names with perceived stability and a track record of capital return (TXN and QCOM being the poster cases at +23% and +32% respectively YTD vs. S&P500 +5%). Looking into next year, we believe Investors will be searching for the next leg of this trend, particularly if the speculated QCOM/NXPI tie-up happens, and we see INTC as the prime candidate. The company trades at by far the lowest valuation vs. large cap peers (just 7.5x CY17E EV/EBITDA vs. median 13.4x – see Figure 15), carries a 2.7% dividend yield, and we believe it can grow top-line mid single digits plus with leverage to both earnings and FCF. Net net, with INTC poised to deliver consistent growth for the first time in a half decade; we look for a rotation in the stock in 2017.

Curtis keeps intact his 2016 estimates for $59.14 billion in revenue, but raises his EPS estimate a few pennies to $2.65. For 2017, he raises his estimates to $62.36 billion and $2.85 from a prior $61.8 billion and $2.76.

My View into the print:  Back in mid July when the company disappointed on Q2 results and guidance, CEO Brian Krzanich did his best to look beyond PCs suggesting they see momentum into the 2nd half of 2016, “While we remain cautious on the PC market, we’re forecasting growth in 2016 built on strength in data center, the Internet of Things and programmable solutions.”  The upgraded Q3 guidance suggested that PCs were better than seasonal, and as Barclay’s Curtis suggested in his note, the company is benefiting from increased diversification brought forth by their Altera acquisition and push into server chips and IoT.

With the pre-announcement out of the way, there may be an opportunity to play for a breakout while selling a near term gap outside the implied move:

Bullish Diagonal Call Calendar:

INTC ($37.75) Buy Nov 40 / Dec 38 diagonal call spread for 85 cents
  • Sell 1  Nov 40 call at .25
  • Buy 1 Dec 38 call for 1.10

Rationale – This trade does best if the stock moves higher on earning but less that the 40 strike into November expiration. With the implied move only 1.25 that range is well outside what is expected. Even of the stock did gap higher above 40 the trade can’t lost money and will be more than a double above that level. There is risk of a slight loss following the event if the stock is unchanged as the sale of the Novembers may not be enough to make up for vol in Dec coming in a little but that’s not a huge problem as it would likely be a small loss or even unched. The biggest risk is if the stock is down significantly as this is long deltas and certainly bullish in intent, playing for a breakout above 38 in the next few months.

For those looking to make short term directional bearish trades into the print, I’ll offer our usual disclaimer, there are lots of things one needs to get right when long premium into events, first and foremost direction, then magnitude of the move. We are generally not fans of using weekly options to play earnings as they offer little margin for error so when doing so you want to maximize possible gains on a realistic move while offering a decent payout if correct, but all the while knowing the entire trade can be worthless this week:

Bearish Earnings Directional:

INTC ($37.75) Buy Oct21st weekly 37.5/36 put spread for .40
  • Buy 1 Oct21st 37.50 put for .50
  • Sell 1 Oct21st 36 put at .10

Break-Even on Friday’s expiration:

Profits: up to 1.10 between 37.10 and 36 with max gain of 1.10 at or below 36

Losses: of 40 cents above 37.50 and up to .40 above 37.10