Intel, AMD earnings: Has the hardware upgrade cycle peaked?

Intel and AMD are expected to report solid to strong second quarter results relative to estimates, but analysts will be closely watching for comments about the second half of 2010 and whether the IT upgrade cycle is about as good as it's going to get.

Simply put, Intel's commentary about IT demand could shape the view of technology earnings for the second and third quarters. Vijay Rakesh, an analyst at Sterne Agee, said in a research note that notebook and desktop sales as well as server demand will all be closely watched. Analysts indicate that server demand has been strong, but the PC purchasing cycle is showing some weakness. Hardware demand translates directly to Intel's results since the company's processors power multiple systems.

Rakesh said:

There are concerns in the supply chain, given the macro commentary with Europe and the state of the consumer. Intel has been a solid execution story, but the macro has been source of concern.

Indeed, Oppenheimer analyst Rick Schafer downgraded both AMD and Intel last week. Schafer said:

Data suggests supply is catching demand, setting the stage for a possible 4Q inventory overbuild/correction--barring a significant second half demand inflection. First to rebound in 1Q09, PCs now shows signs of having peaked...While we don't anticipate a gloom-and-doom double dip in demand, a sudden acceleration in consumption appears equally unlikely...Historically last-to-know, semi managements do not see widespread weakness as yet.

Against this rather skeptical backdrop, Intel is expected to report second quarter earnings of 42 cents a share on revenue of $10.25 billion. As for the outlook, Intel is expected to report a strong second half of the year with third and fourth quarter revenue of $10.9 billion and $11.58 billion, respectively. Much of the conference call reaction will revolve around whether Intel keeps its confidence about the economy in the second half of 2010.

Overall, the hardware demand cycle is supposed to look like quarter over quarter:

Notebook revenue up 10 percent to 15 percent; Netbooks down, but they are almost immaterial to Intel's results; Server sales were up 8 percent to 10 percent; Desktops down 10 percent.

Meanwhile, there are multiple wild-cards to ponder in the second quarter. Even the FIFA World Cup is a factor. Piper Jaffray analyst Auguste Gus Richard said in a research note:

Our Q2 estimate of $10.5B is at the high end of guidance and Street estimates. While we believe our numbers are likely too high due to the debt crisis in Europe and distraction caused by the World Cup, consensus of $10.25B is likely not too high.

Like other analysts Richard said that server and data center demand is strong and even taxing Intel's supply chain. Richard also gave Intel a few passes for PC demand. He wrote:

While there has been an enormous amount of concern about the health of the PC market, we remind investors that it is Q2 which is supposed to be the weak quarter, normally down 3%-5%. Moreover, the debt crisis in Europe, the oil spill in the Gulf and the World Cup have been significant distraction. Against this backdrop, hitting the midpoint of guidance speaks to the strength of demand for PCs, not weakness. Supporting our belief that PC demand is stronger than would be expected are continued reports from other component suppliers that there has been no decline in demand and PCs appear to be healthy. We believe that Intel remains in the early innings of a corporate upgrade cycle and new demand from growing global middle class in the emerging economies.

So what does this mean for AMD? Wall Street expects AMD to report earnings of 7 cents a share on revenue of $1.55 billion. Like Intel, AMD is expected to benefit from server and PC demand, but it has a much smaller---and relatively undiversified footprint. Schafer said:

With nearly all of its revenues tied to PC, AMD has material exposure to any downshift in demand trends.

Meanwhile, AMD appears to be building inventory for a strong second half. If that demand doesn't come, AMD will have some serious issues, said Schafer.