Intel Falls on Soft Demand and Remains Under Review for Potential Sale in Our Portfolio
Intel slumped more than 10% on October 23 after reporting third-quarter earnings results.
Sales fell 4% year-over-year as consumers opted for cheaper laptops and companies and governments pulled back on datacenter spending.
These unexpected COVID-driven headwinds tilted Intel's mix towards lower-priced products, causing gross margins to surprise on the downside as well.
Many of these dynamics are expected to persist in the short term, and management also expects demand from cloud computing providers to moderate as they enter a "digestion period" following several quarters of strong growth.
As a result, Intel guided for fourth-quarter revenue to be down about 14% year-over-year with PC-centric businesses declining in the low single digits and data-centric businesses off 25%.
These challenges seem transitory in nature, and we don't expect them to affect Intel's Very Safe Dividend Safety Score or strong financial health.
The chipmaker's year-to-date free cash flow is still up 29%, resulting in a conservative payout ratio below 30%, and Intel maintains an A+ credit rating with a stable outlook.
Source: Simply Safe Dividends
Intel's margins and free cash flow will also improve after divesting its capital-intensive NAND memory and storage business (about 7% of sales) in a $9 billion deal announced on October 19.
While the issues weighing on Intel this quarter seem unlikely to matter in the years ahead, Intel's longer-term outlook faces uncertainty as its business model potentially evolves.
By routinely plowing around 40% of its revenue back into R&D and capital expenditures, Intel historically introduced the next generation of chip technology every 2-3 years.
This breakneck pace kept the performance and value proposition of its chips ahead of competitors, helping Intel amass dominant market share positions in processors and chipsets used in personal computers and servers.
But Intel's execution has faltered in recent years, driven by the increasingly complex nature of ever smaller chip sizes.
Then, in July, Intel announced a delay in its plans to transition to 7nm processors, preventing those chips from appearing in computers and servers until 2022 and 2023, respectively.
Intel's competitors such as AMD and Nvidia are already shipping 7nm-based processors since they outsource much of their manufacturing to rival chipmaker TSMC, one of the few companies still focused on being at the leading edge.
TSMC already produces 7nm processors and expects to be on the 3nm node by the time Intel gets to 7nm, potentially putting Intel two generations behind. Intel has lost its lead in process technology for the first time in the company's history.
Intel's competitors who use TSMC's leading technology for their production now have an advantage in important areas such as power efficiency, helping them encroach on Intel's leadership position.
"In the interim, Intel is likely to face some of the stiffest competition in at least a decade, if not more. AMD and several Arm customers are eyeing Intel’s client and server market share (and associated profits) with their improved products, and while the company continues to talk up its own products, it's increasingly clear that they don't expect to be able to return to their traditional leadership position until at least 2023."
AMD's market share in server processors doubled to 10% in the last six quarters, and management wants to eventually surpass the company's historical high-water mark of 27% share last reached around 15 years ago.
And in personal computers, AMD says it is now at a high-teens market share, up from 8% just 10 quarters ago.
To stay competitive in the short term, Intel is exploring outsourcing manufacturing of some advanced products, which would be a first for the company. Management expects to make a decision by early next year.
Outsourced production carries lower margins (AMD's gross margin has historically been near 40% versus 60% for Intel) as well as supply risk with multiple companies competing for available capacity.
But the biggest issue is whether or not Intel can one day regain its manufacturing lead, which has fueled the company's historical success.
If the company has fallen too far behind TSMC to catch up with process improvements, then Intel's long-term profitability and market share will likely face greater pressure.
Intel's growing total addressable market may help cushion some of these headwinds as data centers, networking, self-driving cars, graphics cards, and internet of things applications continue expanding.
But Intel's path to becoming a larger and more profitable company in the future has become fuzzier with its technological edge slipping.
As a result, since July the stock has been under review for potential sale in our Conservative Retirees portfolio.
Intel's latest earnings results don't change our thinking on the stock or instill a greater sense of urgency to act.
Shares trade at a forward P/E ratio near 10x, close to a 5-year low. The market appears to be pricing in a lot of the uncertainty facing Intel's future.
Source: Simply Safe Dividends
While Intel's dividend remains safe, we would prefer to own a business with more stable competitive advantages and a clearer path to long-term growth.
As always, we will send out an email prior to the publication of the next newsletter if we make any trades in our Conservative Retirees portfolio involving Intel.
.png)
.png)
