MorningWord 10/19/16: Street Cred

by Dan October 19, 2016 9:25 am • FREE ACCESS

At this time yesterday I considered the reasons why shares of Netflix (NFLX) were up nearly 20% in the pre-market following better than expected Q3 subscriber results (here). Clearly investors were not expecting such a substantial beat after consecutive disappointments in the last two reports that had the stock down 13%. One conclusion I reached on NFLX is that no matter which direction, the post earnings day volatility means:

a good chunk of blame has to be placed on NFLX management’s forecasting of their own business. They kind of suck at it. Or, they are merely bad at communicating with investors quarter to quarter. They clearly have a credibility problem with a decent contingency of shareholders who don’t share their multi-year view.

Which leads me to Intel’s (INTC) Q3 results and guidance given last night that has the stock down 4.25% in the pre-market.  INTC for years was considered a pillar of corporate transparency, offering sales and margin guidance in a plus or minus range, and would regularly tighten that range (while also lowering or raising the midpoint) in the third month of each quarter in regularly scheduled mid-quarter updates. They stopped this practice a few years ago, but have been prone to pre-announce results prior to quarter end, as they did on Sept 16th:

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.

Last night, the company’s results showed that the Q3 bump was the result of better than expected sales of PC chips, as vendors re-stocked in front of the holiday season, while Q4 guidance for PC chips suggest they will be worse than seasonal. And then there is Server Chips, as Business Insider referred to this business as “the business it’s (INTC) bet its future on“:

With 90% market share, Intel is in a strong position in the data center market. But the company is struggling to build upon that strength and is instead seeing its growth slow. Throughout the year, Intel has stepped down its datacenter expectations from “15%” to “mid-teens” to “double digits” — and now it’s saying it’ll come in at “high-single digits” for the full year.

“It’s a problem. Intel has hit its growth target for Data Center Group only once in the last 6 years,” Bernstein’s Stacy Rasgon told Business Insider.

BI highlights the potential for cannibalization between their two fastest growing businesses:

“The enterprise market hasn’t shored up there,” Krzanich said. “But don’t take this as I’m saying [enterprise] is going to be a growth segment…we should see some level of stabilization or less of a decline.”

Bernstein’s Rasgon says it’s a concern that the enterprise is not seeing enough growth. The cloud segment is growing fast, but that likely means it’s doing so at the expense of eating into the enterprise’s business.

Breaking the buzz words down. Enterprise is referring to INTC sales of chips that go into servers that large businesses use to run their networks. The Cloud business is selling chips to company’s that make the chips for public clouds like Amazon’s AWS & Microsoft’s Azure. So you can see if more large businesses are outsourcing their server needs to the cloud, they are not both likely to continue at similar growth trajectories.

Not surprising, INTC has given up all of the gains since its Sept 16th pre-announcement. To my eye the next real support level is $33 – $34:

INTC ytd chart from Bloomberg
INTC ytd chart from Bloomberg

INTC should find a good deal of support in the low $30s, there it will have a greater than 3% annual dividend yield, trading near 14x expected 2017 eps, with the prospects of greater share buybacks in the new year with the digestion and anniversary of their $17 billion Altera acquisition.

To wrap up with the original point, corporate visibility seems poor, at least the messaging is poor, but I suspect that is a result of the lumpiness of the business environment and the political uncertainty globally for both, coupled with rising fears of rising interest rates.

Which brings me to the broad market. despite the S&P 500 (SPX) up just 5% from year ago levels, the vol shocks have been massively skewed to the downside over the last few years, despite the V reversals that at best yield shallow new gains.  The SPX is once again starting to look like a possible slow moving train-wreck:

SPX 2yr chart from Bloomberg
SPX 2yr chart from Bloomberg

So far in this earnings seasons stocks (aside from the freaky NFLX) have not responded to decent news (see banks) and those that report poor results get punished (see Honeywell, IBM, DOV, PPG, and now INTC).  The SPX better hold 2100 in the near term, or 2050 is a foregone conclusion before year end, and possibly 2000. This is a slight change from prior views from late August/ Sept (which I did tweak a bit on Monday – Crank Up the Crazy and Rip Off the Knob). The election result itself is starting to look predictable but the political environment may continue to weigh on business outlook as post election fighting could be even uglier (I think there’s an assumption is can’t get worse, it could with a deadlocked Senate, opposite parties in the House and White House and a losing Presidential Candidate unwilling to accept the results).  And that transition happens into a very likely Fed Funds rate increase in December! I remain cautious on committing new cash to stocks. I believe this is a time to value preservation of capital over return on capital.