Intel warning may indicate fourth quarter, Windows 8 woes too

Intel's third quarter revenue warning signaled that inventory levels in the PC industry are bloated even though they should be depleted ahead of the Windows 8 launch.

The company projected revenue to be $13.2 billion, give or take $300 million (statement). Intel had projected $13.8 billion to $14.8 billion. Wall Street was expecting Intel to report third quarter earnings of 60 cents a share on revenue of $14.2 billion.

Here's the short version:

• Intel is seeing weak demand due to economic concerns.
• Demand in emerging markets is weak. 
• The enterprise PC market is soft. 
• Customers are cutting orders when they should be stockpiling components for the fourth quarter. 
• Data center demand is solid.

The upshot is that Intel's warning covered the third quarter, but may preview ongoing issues in the fourth quarter and into 2013. Simply put, inventory levels at the end of the second quarter were at multi-year highs and not enough PCs are being sold. Ideally, Intel should be seeing decent demand ahead of a Windows 8 launch and the ultrabook parade that goes with it.

Morgan Stanley analyst Joseph Moore said in a research note:

Recall that inventory days after 2Q were at a multi-year high, which is likely to depress factory utilizations and thus gross margins in 4Q. Further, customer inventory levels are elevated still, despite a 7% Y/Y decline at the midpoint in 3Q, when inventory should have been depleted before the Windows 8 release to production a couple of weeks ago. The ultrabook push in 4Q is likely going to drive a high i3 mix in higher-end notebooks.

The big problem is tablet demand and the post-PC era make this PC-Windows upgrade cycle very interesting to watch. Piper Jaffray analyst Auguste Gus Richard said Intel's "warning speaks to the outright decline of the PC demand especially since Q4:11 was the peak impact of Thailand floods and the comps should be easy."

He added:

Moreover, Intel was optimistic regarding demand from Ultrabooks and expected 40% of consumer demand in Q4 or 26% of overall PC demand to be from Ultrabooks. Given the magnitude of the miss in Q3 as well as feedback from contacts, we think this is unlikely.

Betsy Van Hees, an analyst at Wedbush, said that Intel is seeing a triple crunch due to the economy, technology buyers' penchant for tablets and an uncertain uptake for Windows 8.

Intel’s negative pre-announcement doesn’t come as a surprise given the considerable global macroeconomic challenges and our multiple industry checks indicating a very weak PC market further compounded by muted 2H seasonality. Our cautious view remains unchanged due to our concerns for (1) muted consumer’s adoption rates of Ultrabooks, (2) uncertain sell-through of Windows 8, and (3) muted holiday season, particularly for PCs given the increasing uncertain macroeconomic environment.

Williams Financial analyst Cody Acree agreed:

While Intel cited the soft macro, the company stopped short of pointing to any degree of PC cannibalization by tablets and/or smartphones. Although it’s hard to define the impact, we believe it’s very difficult for anyone to argue that tablets are not having a material negative impact on notebook sales, particularly in a soft economy when consumers’ discretionary budgets are tight.