Why Intel Dropped After Earnings

| About: Intel Corporation (INTC)

Summary

Intel's lack of revenue growth seems unsolvable in the short-term.

The company's inability to grow in new segments leaves it at the mercy of macroeconomic conditions in the PC and server markets.

Intel management remains a weakness for the company as it struggles to grow.

At first blush, Intel's (NASDAQ:INTC) earnings seemed pretty benign, so the stock dropping almost $3 might seem surprising. Clearly, not everyone dropped the stock for the same reason, but we can review the report and try to identify areas that would weigh on people's decisions.

I wrote an article over 10 days ago, and generally like to before earnings so I can easily see where my head was at prior, and what changed. In reality, nothing in the earnings really surprised me much. It might be the underlying problems with the company getting visibility that caused the minor selloff.

From a high-level view, revenue was up 1%, but operating income and net income were both down 3% and 1% respectively, year to year. The Client Computing Group was down 1%, Data Center Group was up 5%, Internet of Things Group up 8%, while Software and Services was down 3%. The biggest disappointments seem to be the Data Center Group and Internet of Things showing such minor growth.

If we look closer, we'll see the Client Computing Group unit shipments dropped 16% year to year. This was largely offset by ASP increasing 17% over the same period. Both of these can explained by the largest drop in volumes (33%) being for tablet processors, although Intel management did indicate their product mix was richer in the PC market as well.

The Data Center Group was reversed, with volume up 7%, but ASP down 1%. Management framed this by saying that this was due to the networking group growing significantly faster than the servers. This brings further attention to the fact that even with this fast growth in networking processors, the overall volume was up only 7%, raising concerns about server processor sales in this segment. Intel's spin on this was that Q4 of 2014 was very good quarter, making relative comparisons challenging. This ignores that Q3 to Q4 only showed 6% growth, so however you spin it, volumes were not impressive.

IoT again showed disappointing growth, showing only mid-single digit growth year to year. This was supposed to be a strong growth engine for Intel a year ago, and has stalled.

One point I want to bring up is that Intel's revenue forecasts for 2016 include revenue for Altera. Although Intel has not completely broken down how much they expect from this segment, it was revealed that Q1 revenue was expected to be around $400 million. Also consider there will be 53 weeks in 2016 for the company, the extra being in Q1, and it is clear that Intel's revenue guidance is quite soft.

So, in short Q4 was a lot like Q3. Anyone who was hoping Q4 would show marked improvement was disappointed with the earnings report. Investors are beginning to realize Intel is not sure how to expand, and management is unable to initiate strategies that lead to successful growth. As investors realize what I had a few years ago, Intel management lacks vision and capability, the stock will reflect that. The offset of that is the company continues to offer an attractive dividend, and actively purchases its own stock, all while still being very profitable. This makes it an easier pill to swallow, but it does not totally exonerate management from its poor performance.

A lot of Intel's situation I covered in my previous article, and this one is mainly about earnings, but I do want to cover some general points as well.

One of the points I mentioned in passing was that tablet sales were down 33%. If you wanted an example of how badly Intel management has performed, you can look at this. Many of us decried Intel's aggressive, and expensive, attempt to force itself into the tablet market, at a cost of over $10 billion, and climbing. It is incredibly obtuse, and showed a management that was baffled by market changes, and reacted to them rather than understood them. While management tries to paint a picture of a "richer mix" in the Client Computing Group, and frame it as a success, clearly the salient reason for the increases ASP is the tablet market collapsing on them. After spending so much to enter it, this hardly seems like a success. In fact, it's an egregious failure that should never have happened.

As a corollary to that, there will be some that will take from the volume decrease that AMD gained CPU market share in Q4. This probably is not true, and if it is, it has to be very minor. Since the major volume drop was in tablets, and the desktop and mobile PC market showed a much lower drop, Intel effectively maintained market share.

Skylake continues to be a failure for Intel. Yields are still not high, but progressing, and the performance improvement is very minor, and it has a well publicized bug. I know the bug is very minor, but even with that, on a visceral level, I could never buy one now. Errata are not uncommon, but it's one thing to know this, and another to actually see a processor exposed for it. The emotional side often wins this battle.

The disappointing poor performance reminds me of Haswell, a processor I was convinced would perform very well when I saw the architecture, then was dead wrong when it was released. But, there's a happy ending to this story. Haswell now performs quite well compared to Ivy Bridge, whereas when it was released it showed a very minor improvement. Obviously, software optimizations are ongoing, and certainly helped Haswell realize its potential many months after its release. The same may hold true for Skylake, so while the early returns are poor, this does not necessarily mean it is a dud. But, for now, it is.

Management also indicated that the depreciation for equipment would be significantly less, on the order of $1.5 billion, in 2016, due to the lifespan being extended from four years to five years. This concerns me because it comes after Intel has indicated delays in moving to new fabrication technology, and this does seem to play into that a bit. Intel management denies this is related though, but I am not sure I believe them.

Looking a little more broadly, Intel is in a situation where its performance is largely dictated by the macro-economics of the markets it is in. Although that is causing some pain now, it really is best case, as it means the company is so dominant in these markets, there is not much to be gained that the company does not already have. This is not a permanent or unassailable position, and while Intel can not do better than the PC market, or server market, it can do worse. Right now, the server competitors (AMD (NYSE:AMD), IBM/OpenPOWER (NYSE:IBM), ARM (NASDAQ:ARMH)-camp) are not seriously impacting Intel. All three are progressing, and could impact Intel's server dominance in the future. In the PC market, AMD products are so far behind Intel's, they do not compete well in much above the lower-end segment. AMD's Zen is clearly an attempt by the company to move its product upstream, and considering it is a complete redesign and has been moved to a far superior manufacturing process, it should have at least some success in doing so.

Investors now realize Intel has to grow in other areas, and so far earnings after earnings show this is not happening. IoT is clearly not growing at a rate the company had hoped for. Phones are still languishing, although saying it's failed is probably premature, as 2016 is an important year and could turn things around. The memory group is still a very small part of the company, and even with the all the fanfare around 3D Xpoint, it will not even be monetized until 2017, with samples going out in 2016. On top of that, the market for it will be quite small, as it will not replace DRAM (too slow), or Flash (too expensive) in the near term, although it may be used as such in a small segment of those scenarios. Most likely, it will find more success in storage class memory first, and even there, competing technologies are also being released.

To sum it up, the earnings were not really that bad, and I think a bigger part of it is that investor's hoping the company will start growing again are beginning to lose that hope. I believe they are also seeing how poor the management team is. But, the company is still returning a lot of money to investors, still very profitable, and still dominant in two very major and profitable markets. IoT is not really looking that good, but the low-end phone market could start to develop momentum in 2016, and Intel has the technology to play effectively there. There are dark clouds in the form of better server and PC competition, but they're off in the distance, and it is not clear if they will ever materialize enough to rain on Intel's parade.

I would not buy this stock, as I can think of companies with better upside, but there's also little reason to panic as the company is very stable and profitable. I do not believe that is going to change in 2016, although we should watch to see how the competition shapes up this year, to better know what to expect in 2017.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.