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Intel profit margins may shrink as inventory rises

Intel Corp's profit margin may shrink this year and next as inventory of computer chips builds up and the company cuts prices to increase sales.

Gross margin became the focus of Intel analysts including Morgan Stanley's Mark Edelstone and Merrill Lynch & Co's Joseph Osha after Intel reduced its third-quarter gross margin forecast last month.

Intel Chief Financial Officer Andy Bryant will probably say margins haven't improved when he updates the company's forecasts later today. Every percentage-point decline reduces Intel's earnings by US$0.01 cent a share, Edelstone wrote this week.

"It all centers on gross margin," said Daniel Morgan, who helps manage US$6 billion including Intel shares at Synovus Investment Advisors in St. Petersburg, Florida. "Inventories are up -- now we've got a problem."

A buildup in inventory is adding to costs and cutting into profit, reducing the benefit of what analysts expect to be a 10 percent sales increase next year to a record US$38.2 billion. Intel last month cut its third-quarter gross-margin forecast to 60 percent from 62 percent.

Intel's inventory is three to four weeks above "normal" levels and will cause "gross-margin pressure," Edelstone wrote in a report.

"Intel has historically proven to be a gross-margin-sensitive stock," he said.

The company's gross margin probably peaked when it widened to 63.6 percent in the fourth quarter last year, Edelstone said in his note.

The squeeze on margins is going to tighten, analysts such as Banc of America's John Lau in New York said. Lau lowered his forecast for Intel's gross margin to 59.9 percent for this year and 60.7 percent for 2005 in a note to clients published Aug. 25.

Intel ended June with a record US$3.2 billion in inventory.

The company slowed production at some of its plants, increasing costs, and cut prices on some chips by as much as 35 percent to help to reduce the backlog.

The stockpile raised concern that orders for computers and electronics are not growing fast enough and that Intel isn't controlling its production well enough, investors including Dreyfus Corp's Mark Herskovitz said.

"The question of inventory is very troubling," said Herskovitz, who manages US$2.2 billion in technology stocks including Intel in New York.
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