Last week, I applauded Intel (NASDAQ:INTC) when the company announced a $6 billion debt raise to help fund its buyback plan. Being one of the Intel bears out there, I have argued for several months that Intel's declining net income meant cash flow would be less than in prior periods. Since I didn't think the dividend would be touched, the most logical place to recoup some of the reduced cash flow would be to not buy back as many shares. That would have a further negative impact on earnings per share, for those that play the valuation argument.
You would think that this debt and buyback news would be appreciated by everyone out there. Well, you would be wrong. Intel actually received three more downgrades after the debt sale, which piles on a recent round of negativity. The stock has not been able to gain traction on what should be positive news, since fears of a reduced buyback have been calmed. For those believing in Intel's long-term future, now might be the time to get in. Let's look at Intel again.
Three more downgrades:
The first negative note was one from an analyst at Raymond James. Hans Mosesmann downgraded the stock from Market Perform to Underperform, and cut his 2013 earnings estimate to $1.88. That's a few percent below the current $1.94 analyst average. The analyst believes that Intel is headed for a "gross margin disaster". He thinks that Intel's share gains against Advanced Micro Devices (NYSE:AMD) will fade, and ARM Holdings (NASDAQ:ARMH) will continue to gain share. The following quote represents the main part of his argument:
"We believe the 62%-65% gross margins seen over the last three years were the exception to the rule. Over that time, Intel gained share vs. AMD in both PCs & servers and benefited from the last real Windows enterprise upgrade cycle. With these benefits abating, Intel has a number of new challenges in the form commoditization of x86 (by ARM), price competition in both PC and data center markets (also ARM) and an increasing capex burden (with little to no growth). We believe mid 50% (and potentially low 50% over time) gross margins are an increasing reality as opposed to a downside scenario, and investors should brace for lower estimates. With ARM-apps processor pricing at 15-20% of x86 vs. Intel on recently launched Surface platforms, we believe a gross margin baseline below 55% should not be surprising. The data center assault from ARM will be next, and that could prove even more damaging as this is the only area where Intel has posted op. profit growth in 2012."
I'm guessing that this analyst believes that Intel's Q4 is the start of a trend. Intel guided to Q4 GAAP gross margins of 57%, compared to 63.3% in Q3 and 62.5% in last year's Q4. Even if the guidance turns out to be a bit conservative, you're still looking at a decline in the hundreds of basis points. For 2013, Mosesmann sees $54.5 billion in revenues for Intel, slightly above the $54.46 billion average now. His 58% gross margin forecast is a bit more bearish than others, which is why his earnings per share estimate is 6 cents below the current average. He also is not in love with the CEO change, believing it won't do anything to address the current Intel situation.
The second bearish note came from Nomura. Analyst Romit Shah reiterated a Reduce rating on Intel, in a joint note out with analyst Stuart Jeffrey on Apple (NASDAQ:AAPL). The analysts' dual-authored report is regarding the prospects of Apple dumping Intel's processors in its Mac computers and instead using Apple's custom-designed processors based off ARM technology. The analysts think that Apple could dump Intel for three specific reasons:
"the vertical integration of Mac OS and chipset could aid user experience, the technology is now in place for ARM-based chips that can support a desktop experience, and it would mean saving more than $100 off the cost to Apple of Intel's "Core" series of chips."
Intel losing Apple's business here would certainly be negative, and would be a nice win for ARM. We've heard rumors of this in the past, but it seems unlikely for a couple of years. But if Apple could save what these analysts are saying, it's a no-brainer. Apple's Mac margins would rise by a significant amount. That would be a relief for Apple shareholders, who have seen shares dropping lately, partially on margin fears.
The third negative note came from Miller Tabak, which lowered its price target from $25 to $23 and reiterated a Neutral rating. Analyst Brendan Furlong stated that data on build rates of original design manufacturers, so called ODMs, have been softer than expected in December. The analyst said that weaker demand into a seasonally strong quarter is not a good sign for Intel. Also, he stated that total ODM revenue appeared to have dipped 5% in November, which is usually seen as a positive month. Furlong cut his Q4 revenue number from $13.5 billion to $13.3 billion, and earnings per share number from 45 cents to 43 cents. He also cut his 2013 full year revenue number from $54.4 billion to $52.9 billion and earnings per share from $1.93 to $1.70.
Furlong advised investors hold off on shares until PC data reaches a floor, stating the following:
"Intel is suffering from a double headwind of negative PC market growth and excess inventory. We see these issues lasting into 2013. Until the company gets inventory under control, so that gross margins can put in a bottom, we do not see investors rushing to buy the stock. We think the company can eventually get inventory under control but it is tough to tell when the rot stops in the PC market. The stock has declined significantly in the last several months and valuation appears to be attractive. The dividend is also attractive at these price levels. While the valuation and dividend are attractive, we are maintaining our Neutral stance on the shares until we see some signs of stabilization in the PC and server markets."
Comparisons to the others:
When it comes to Intel versus ARM, I don't think people quite realize the scale we are talking about. Just look at the following comparison table, and I've thrown in AMD as well.
ARM's revenues are less than 2% of Intel's currently. Yes, ARM is growing at a much faster rate, and earnings are at least rising. Analysts are looking for a rebound in Intel's revenues next year, which you cannot say for AMD.
Back to Intel. Over the last couple of weeks, estimates have continued to trickle down. In the last week, Intel's Q4 revenue estimate average has come down from $13.58 billion to $13.54 billion. That now represents a 2.5% drop over last year's Q4, and we're starting to slide away from the $13.6 billion revenue midpoint Intel guided to. That's also pushed down the yearly number a little, with analysts now expecting a 1.0% yearly decline in revenues, compared to -0.9% previously. The 2013 numbers have come down as well. Over the past few months, analysts were looking for 2.0% to 2.1% revenue growth next year for Intel. That growth figure is now down to 1.9%.
On the earnings per share front, we haven't seen any change to the 2012 number, which still stands at $2.11. However, since my last update, the 2013 numbers has come down another penny or two (depending on what site you use) to $1.94. It seems that a lot of analysts are really starting to worry about declining margins with Intel. This really worries me a bit because of the buyback. With the debt sale to make sure the buyback would still be firing on all cylinders, you would logically think that estimates might come up a little. Nope, you would be wrong, as they've gone in the exact opposite direction.
We've seen some slight changes on the price targets as well. The average price target has come down from $23.47 to $23.30 over the past week, while the median target has risen from $22.75 to $23.00. The midpoint of those two is $23.15, which implies about 15.3% upside from Monday's closing price. The average analyst rating is a 2.6, which implies a slight buy, not too much above a hold.
Conclusion - the bulls have disappeared:
You would have thought that the debt issuance would have been a good thing. As many pointed out in my last article, Intel got such low interest rates on the debt that the savings in dividend payments (from the reduced share count) should more than cover the interest expense. But despite good news on the buyback, we got three more negative analyst notes. Analysts currently fear a huge margin drop for Intel, and that is reflected in current earnings forecasts.
You would think at some point the analysts would get so negative that Intel would have to beat expectations. I believe we are getting closer to that point by the week. While ARM may be growing faster, Intel still has a huge revenue base. Intel isn't in bad shape, compared to where AMD stands. Now, if Apple were to ditch Intel then the argument might change, but that appears unlikely for now. At $20, Intel sports a 4.5% yield, and that seems to be a good entry point for investors. I'm a bigger fan as we head down towards the $18 to $19 range. I think shares could be further pressured by more downgrades in the short term. Also, any market selloff due to fiscal cliff issues could push Intel down a bit. But for those believing in the long term for Intel, you might want to start looking at this name again.
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