Intel's Q1 Was A Dinosaur Egg

| About: Intel Corporation (INTC)
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Summary

Intel's Q1 2015 revenue was flat from Q1 2014 revenue.

Datacenter segment competition will heat up in 2016.

Process technology leadership no longer automatically leads to revenue growth.

Intel (NASDAQ:INTC) reported Q1 2015 results on April 14, 2015 and held its analyst conference to talk about them. Guidance for 2015 was also issued. It would be hard to argue that Intel will offer investors any alpha over the S&P 500 this year. I would argue that technology trends have undermined Intel's leadership and Q1 was a warning that Intel has to change significantly if it does not want to stagnate.

Results by Segment

Intel now reports four named segments (groups) plus an Other segment. If arguing the bright side of the future, you could focus on the Data Center Group. With $3.7 billion in revenue, this segment was up 11% y/y. But this may be the lull before the storm. Intel's main traditional competitor for the server CPUs that go into datacenters (or the cloud, if you prefer), AMD (NASDAQ:AMD) has almost disappeared from that market. So as demand for datacenter CPUs has grown, Intel has simply reflected that demand. But with 64-bit ARM architecture designs testing this year, and AMD and a host of other companies going into production in 2016, the game is about to change. Intel is well positioned to put up a fight, but it probably won't be able to keep both high margins and near total dominance of unit sales into this sector.

The PC Client Group, which includes personal desktops, notebooks, tablets, and phones, saw revenue drop 8% y/y. Tablet sales improved, but Intel's market share is still minor. Notebook sales improved, perhaps partly due to an AMD share loss. But desktop sales were down enough to result in an overall drop. If customers don't buy desktops, Intel's strength does not matter much. While I would not call the Intel charge into mobile a failure yet, I don't think process technology (discussed further below) is going to be much of a competitive advantage, the way it has been for 3 decades in desktops and servers.

The IoT (Internet of Things) Group revenue was up 11% y/y, but at $533 million is a minor consideration so far. Same for Software and Services at $534 million, down 3% y/y, and Other, up 13% y/y to $615 million.

2015 Guidance

Revenue in Q1 2015 was $12.8 billion. Full 2014 revenue was $55.9 billion.

Intel is guiding to flat 2015 revenue compared to 2014. Profit (net income) may be up or down some, but essentially it looks like 2015 is a no-growth year. As an investor, lack of growth is your enemy, unless you are adequately compensated by a high yield.

A big risk for investors is that this time next year, guidance for 2016 will also be close to flat. At that point, it will be hard to argue that Intel is going to come out on top in the current technology transition.

Cash, Cloud, and Clout

Intel still generates a lot of cash from operations, $4.4 billion in Q1. Intel is good about returning cash to shareholders through dividends and stock buybacks. Intel ended the quarter with cash and equivalents (including investments) of about $14 billion, and about $13 billion in debt.

Intel could return to revenue growth by buying up smaller, faster growing companies. The problem is that strategy has to be weighed against the constant need to reinvest in process technology (making ever more transistors in the same area of silicon).

If you look at Intel's history, you might fairly conclude that it is a one-trick pony. It put a CPU on a chip, then started making the chips smaller, and expanding what the CPU could do. Intel kept in front of competitors by having more advanced process technology. During its entire history, it has been able to put more transistors in a given area than its (now mostly forgotten) competitors. It's a great trick. Smaller is better, and today Intel chips are coming out of its factories at 14 nm (nanometers), while most competitors are still at 28 nm. However, it is possible AMD may bring out 16 nm chip samples before the year's end.

Where Intel dominates, as in server and PC chips, its process technology lead makes it hard for others to compete or gain market share. Everyone fabless has to wait on Taiwan Semiconductor (NYSE:TSM) or some other foundry to play catch up.

Why hasn't that same advantage resulted in most phones and tablets running on Intel CPUs? Because years ago Intel was not prepared to integrate the analog components of phones, and did not work hard enough early enough to modify its chips to efficiently run the Android operating system.

The result is a world where the cloud mostly runs on Intel processors, but the clients are running on the ARM architecture, with Qualcomm (NASDAQ:QCOM) as the leading manufacturer, but just one among a swarm of competitors. Intel's process technology applied to mobile chips is not going to change that, not by itself.

Conclusion

Intel bulls will point to Q1 EPS being up 8% y/y. It is a testament to good management to squeeze profits out of a stagnant revenue stream. They will talk about wonderful 14 nm processors being sold. But if unit demand is stagnant, then it does not matter if a processor is made at 14 or 16 or 20 or even 28 nm.

Intel pays a nice dividend, 3.03% at the April 14 closing price of $31.49. Intel is not going away any time soon. It is a good stock for a low-risk, low return portfolio.

I might be wrong about ARM-based competition hurting Intel's datacenter business starting in 2016. But until I see either a revival of client CPU demand, or an exciting acquisition, I am not interested in the stock.

Disclosure: The author is long AMD.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.