Shares of Intel (NASDAQ:INTC) were trading down 3% after hours on Thursday as investors dissected a disappointing quarterly report (press release available here). Intel reported earnings of $0.51 on $13.8 billion in revenue while analysts had been looking for $0.52 on $13.7 billion. To me, this current quarter is a perfect example of why a stock's price going into earnings plays a critical role in how the numbers are received by the street. Let's start with a chart of Intel over the past twelve months:
Over the last twelve months, shares are up 21%, which does lag the S&P 500; however, shares have moved up dramatically since the beginning of December. These gains accelerated over the past five sessions as numerous analysts upgraded INTC. As the stock price rises, the bar is higher for the quarterly report. If shares were still trading under $24, I think this quarter would have been better received than it currently is because it wasn't really that terrible.
Intel has been hurt by weak demand for PCs, which drive the majority of the company's revenue, though the company is working to shift into mobile and does have a data center group. In the fourth quarter, PC revenue was flat year over year at $8.6 billion. For the entire year, PC revenue was down 4% at $33 billion, so we saw some sequential improvement in the fourth quarter.
The PC market is obviously challenged as consumers shift to tablets, but I think reports of the PC's death are greatly exaggerated. PCs still perform some functions better than tablets, and enterprise demand for PCs has been more resilient than consumer demand and will help to stabilize the market going forward. Don't get me wrong; I am not arguing that the PC market will be a major driver of growth, rather it should be less of a drag going forward. I am looking for about a 0-2% decline in 2014.
Gross margins will also pretty strong in the quarter at 62% which was up 4% from last year's 58% figure and exceeded guidance by 1%. For the full year, gross margins were weaker at 59.8% vs. 62.1%, so this quarter's 62% was a welcome figure. Against these positives, there were two drivers for this quarter's weakness. First, the tax rate came in a bit higher than anticipated at 26% (guidance was for 25%). Moreover, the company did spend a bit more on R&D and MG&A, which totaled $4.8 billion.
These higher R&D expenses, which were up about 7.5% year over year, were likely driven in part due to the company's effort to develop mobile chips to gain exposure to the growing smartphone market. In the quarter, the company's "Other Intel architecture operating segments" ran a steeper quarterly operating loss of $620 million compared to last year's $495 million loss. This segment includes its tablet and phone units. While short term investors often sell on losses like this, that is precisely the wrong strategy for long term investors.
If Intel is going to be able to grow earnings and revenue going forward, it will need to diversify away from the struggling PC market and into higher growth markets like smartphones and tablets. This investment is necessary to foster growth going forward and compete against the likes of Qualcomm (NASDAQ:QCOM), though Intel does appear to be focused more on lower-end smartphones at the moment. I would expect this segment to continue reporting losses in 2014 as it works to gain market share in 2015.
Speaking of the future, let's take a moment to examine management's 2014 guidance. For the full year, Intel expects flat revenue, gross margins of 60% (roughly in-line with this year's 59.8%), R&D plus MG&A of $18.6 billion, and a tax rate of 27%. This guidance suggests that 2014 will end up being pretty similar to 2013. As a consequence of guidance, I would continue to look for $1.89-$1.97 in 2014 earnings.
All in all, this was an alright quarter that showed some stability in the PC market and continued investment in mobility. 2014 will be roughly flat to 2013, and bulls have to hope mobile chips can start to power growth in 2015 and beyond. After the drop on results, Intel shares are now trading at about 13-13.3x forward earning. Given the lack of near term growth potential and risk that Intel cannot gain a sizable foothold in mobile, I think this is a pretty full valuation.
With a 3.5% dividend yield, I wouldn't go out and short shares of Intel. At $25-$25.50, shares are trading right around fair value. If investors want to bet on the PC, I continue to believe they will do better in Hewlett-Packard (NYSE:HPQ), which trades less than 8x earnings. For investors focused on mobile, I still would rather be in an established player like Qualcomm despite its pricier valuation. Sometimes the best position is no position, and that is where Intel is right now. I would consider going long if shares fall back below $24 and would consider going short if shares reach $27. Right here, shares look range-bound and fully valued. I wouldn't buy on this report.
Disclosure: I am long QCOM, . 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.