Intel: The Empire Strikes Back

| About: Intel Corporation (INTC)

I know, somewhat dramatic of a title, and perhaps a bit early, but I'm pretty sure that Intel (NASDAQ:INTC) proved a lot of the nay-sayers wrong with its earnings report Tuesday night. People unfamiliar with the story (and how the stock market actually works) will see that Intel's numbers were down across the board, in particular that sales were down, net income down, and margins down, and immediately conclude that it's time to short the stock. So, why in the world didn't the shares crater in the after hours session, and why am I more bullish now than ever? Read on to find out.

Q1 In Line, Q2 Just Fine

The truth is that given the IDC and Gartner reports, short sellers expected that the company would either miss for Q1 entirely or that it would barely hit Q1 numbers and then guide way down for Q2. Well, they were wrong. As I outlined in my earnings preview, while PC units were likely to be down Y/Y, a big chunk of that drop would be in the netbook/low end notebook space, and that seemed to be the case. CFO Stacy Smith pointed out that netbook sales were now essentially zero, and this is evident in the numbers of the "Other IA" group. But see, losing a ton of unit volume at the $25 - $30 chip level isn't exactly the same as losing a ton of unit volume at Intel's ~$100 ASP for its "Core" products.

Now, the really nice thing is that Intel actually beat the consensus estimate of $12.86B in sales for the Q2 guide by guiding for $12.9B at the midpoint, driven largely by inventory replenishment due to the upcoming "Haswell" processor launch. This takes away a lot of the meat from the bear argument that the company will have to guide down the year.

Gross Margins - Calm Down

Gross margins this quarter came in light. The excess capacity charges were worse than expected, which is what led to the company ultimately taking down older generation capacity (think 32nm and even 45nm - I doubt they are taking down 22nm) and reducing the capex forecast for the year as the older equipment gets refit for the next generation (14nm, 10nm) process technologies. The company still expects full year gross margin at 60%, and further expects the coming quarter to see gross margins of ~58%, so the bottom may be in on the margin front. You can only really see a bottom looking backwards, but this seems like a pretty good time to bet on such a bottom.

Note that the gross margin decline is due to startup costs as well as excess capacity charges - not because competition is particularly pressuring ASPs. Many retail investors miss this subtle point, but it is an important one to keep in mind.

Capex Surprise

Remember how the sell-side was agonizing over the $13B capex number? Well, the full year guide for capex is now a mere $12B, and the actual capex for the business (excluding EUV) is ~$10B, a Y/Y decline from 2012. This decline is largely due to the reuse/refitting of old equipment, and I am sure that the Street is happy with this downward revision in capex, especially since this was the big "problem" that marred last quarter's otherwise decent results. Further, management was very clear that capex could be modulated downward should expected demand not materialize, further putting a damper on the bear case...for now.

"Bay Trail" - Shutting ARM Out Of The PC Market

The big fear is that cheap, ARM (NASDAQ:ARMH) SoCs would make significant progress in the PC space because they are perceived to be "cheaper" and "lower power". Luckily, as I expected, the company is bullish on its latest "Bay Trail" Atom part (22nm) and talked up its performance relative to competition significantly on the call. My guess is that the Atoms actually do quite well on gross margins, but total gross margin dollars are lower per unit (obviously).

The net effect, I believe, will be an increase in volumes thanks to a strong defense in the PC space (the company mentioned sub $300 touch-enabled, thin-and-light PCs) with these processors (goodbye, Windows RT), as well as a potential game-changing move into the Android tablet space. I expect established vendors such as Nvidia (NASDAQ:NVDA) and Qualcomm (NASDAQ:QCOM) to keep the lion's share of the high end apps processors for Android, but Intel will creep in and take some share if its chips are as good as claimed.

In short, Intel realizes that it will either need to risk cannibalizing its own higher end CPU sales, or an ARM vendor will do it for them. Clearly some revenue is better than no revenue, and Intel's management once again proves themselves capable and realistic.

Servers - Ace In The Hole

Intel's datacenter group grew 7.5% Y/Y as both units and mix were up over the year ago period. This, keep in mind, is growth that occurred despite the wave of upcoming 22nm server parts (and the people buying these systems know what's coming down the pike) that not only refresh the products in the traditional market segments, but also expand the company's offerings into new segments. In particular the Atom-based "Avoton" for micro-servers and "Rangeley" for comms/networking should open the floodgates to significant unit volume growth.

Double-digit growth seems very likely, and I further expect the growth to be quite back-half loaded. As the excess capacity charges disappear, and as unit volumes ramp, management expects operating profit in datacenter group to get back up to the 50%+ range after slumping over the last several quarters. This should provide some nice operating leverage exiting the year.


Q1 wasn't as bad as expected, Q2 guide wasn't as bad as expected, and the world isn't ending for Intel. This is a powerhouse company in the midst of a very important transition, and I believe that, once again, betting against these guys in the long run, especially with the nice fat dividend and a large competitive moat, is - to recycle my analogy - picking up pennies in front of a steamroller. The short interest in Intel is at a record high of 5% of the float, and I believe that there will be some squeezed shorts over the next year, if not the next few months.

Good luck!

Disclosure: I am long INTC, NVDA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am also short ARMH