Short Sellers Are Targeting This 'Forever Stock'

David Sterman's picture

Tuesday, November 18, 2014 - 12:00pm

by David Sterman

Jack Welch, the legendary former CEO of General Electric Co. (NYSE: GE), repeatedly cited a 1975 report in the Harvard Business Review. It said that market share leaders are the better company compared to the peer group, as they “are likely to have a higher profit margin, a declining purchases-to-sales ratio, a decline in marketing costs as a percentage of sales, higher quality and higher priced products.”

That strategy was well-honed by chip giant Intel Corp. (Nasdaq: INTC), which has consistently taken market share from rivals such as Advanced Micro Devices, Inc. (NYSE: AMD). The proof of the scorched earth strategy was found in the numbers: Intel’s gross profit margins surged to 65% in 2010 from 52% in 2007.

To be sure, Intel has endured a challenging slowdown in the PC industry, yet an impressive share price rebound over the past two years suggests the worst of the PC storm has passed. As we have said on a number of occasions: we think Intel possesses the key ingredients of a “Forever Stock” -- a wide moat around its business and a solid history of buybacks and dividends. But even the best companies need to be assessed with an objective eye as its respective industry conditions evolve. And with Intel no longer the deep bargain it was two years ago, it’s worth taking note of a surging short interest.

From the middle of October to the end of the month, short sellers, who boosted their short interest in Intel to 204 million shares from 137 million. That’s a fairly rapid spike, and it’s worth focusing on what the shorts are thinking.

Short sellers aren’t targeting Intel simply on the basis of valuation. Though the forward price-to-earnings ratio has risen to a current 15 from 10 a few years ago, shorts would have focused on that metric earlier this summer, when shares had already surged to the mid-$30’s. Instead, the short sellers are suddenly focusing on what they heard (and likely didn’t hear) when Intel delivered Q3 earnings.

When Intel issued results on October 15, the company noted fairly strong demand for its core PC chip business, with shipments rising 15% from year-earlier levels. Trouble is, the PC market was flat year-over-year. Although Intel took some market share from AMD, analysts suggest that Intel is “stuffing the channel,” which means that inventories among PC customers may now be too high.

Intel obliquely hinted at the possibility of an inventory overhang by issuing Q4 revenue guidance in the $14.2-to-$15.2 billion range. That’s wide enough to drive a truck through. The key takeaway: Intel may be headed for a quarterly shortfall if the inventory position comes back to bite. Those inventory concerns are why both Morgan Stanley and Bernstein Research recently lowered their rating on shares. Even long-term investors can’t be blamed for exiting a stock in the face of near-term issues and re-entering the stock (at presumably lower prices) when such news has been digested.

Need For Reinvention
Intel’s core PC market has undoubtedly peaked, and the company is losing a significant amount of money on its new mobile chips, suggesting any payoff in that niche is several years away. So management is under the gun to focus investors’ attention on new opportunities.

That’s likely to be a focus when on Intel when it holds its annual analyst day on Thursday, November 20. Management delivered a preview of that meeting in early November, discussing new initiatives such as wireless charging, higher levels of processor encryption (which may hopefully spell the end of passwords) and new interfaces and form factors for its chips.

The challenge for Intel: convert those new initiatives into sizable market opportunities. That’s why the upcoming analyst day is so important. If you intend to own shares of Intel in 2015, then you need to have a clear view of its technology roadmap. The company will simulcast its day-long meeting to the public, and you can access it here.

Risks To Consider: Crossing the 200 million share threshold means this is a crowded short, and if Intel delivers solid quarterly results in January, then a short squeeze could push shares higher.

Action To Take --> The rising short interest suggests a near-term bumpy path for Intel. The short sellers are likely focused on a potential Q4 shortfall, and if you are a buy-and-hold long-term investor, then quarterly concerns shouldn’t be of too much concern. But even for buy-and-hold investors, it’s wise to continually perform a gut check on the company’s long-term growth plans. Intel’s ability to keep growing is tied directly into our thesis that the company is a dividend-and-buyback powerhouse. Intel will always have a wide moat around its business, but will need solid execution to deliver a yet higher level of shareholder perks.

During Intel’s meeting with analysts, the company will need to explain how it can boost free cash flow (to support ongoing dividends and buybacks) while still heavily investing in new niches. They are seemingly paradoxical goals, and short sellers are betting that analysts will either need to lower their 2015 and 2016 free cash flow targets, or that analysts will trim their 2015 sales growth estimates. To be sure, short sellers aren’t positioning for a massive decline in shares. Intel has too many virtues for that to happen. If you have time to monitor the company’s comments at the upcoming analyst day, then it would be time well-spent.

Despite near-term difficulties, Intel is a Forever Stock -- a company so powerful and shareholder friendly that you can buy shares and virtually own them forever. We're excited to announce Top Ten Stocks groundbreaking new research report, "The 10 Stocks To Own For The Rest Of Your Life." This never-before-seen list of 10 Forever Stocks has gained an average of 829% over the past decade, beating the S&P 500 by more than 7-to-1. Dave Forest, the newsletter's chief investment strategist, recently shared his new research and a few of these stocks with a live audience at St. Edward's University, and now we want to share them with you. To watch the filmed version of this special presentation, go here now.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of INTC in one or more of its “real money” portfolios.