Intel's Credibility Damaged, Stock Still Inexpensive

| About: Intel Corporation (INTC)


Recent news and results at Intel have damaged management's credibility.

On the other hand, shares still trade at a reasonable level.

Investors shouldn't be in a hurry to sell here, but should probably assume the company will underperform its own expectations until proven otherwise.

Having followed Intel (NASDAQ:INTC) for quite a long time now - including having owned it for multiple years but thankfully selling out near the peak - I have to say that I've lost some patience with the company's trend of persistent over-promise and under-deliver. Recent news, Q1 earnings and the accompanying bombshell about laying off 10% of the workforce serves to substantiate that view.

In Intel's defense, of course, many of the challenges they face - such as structurally lower demand and longer replacement cycles for PCs - are outside of their control. On the other hand, their execution on things "inside" their control - mobile, data center, etc. - has been patchy.

The good news from an investment perspective is that Intel is still reasonably priced for a large cap - it trades at a below-market multiple of earnings with a good balance sheet, while offering a strong dividend and modest long-term growth prospects as growing segments like data center and Internet of Things will increasingly offset declines in legacy PC chips.

If It's Not The Market, It's The Management...

I'm not going to dwell on the continuing declines in PC demand, which led Intel to decrease guidance for the year, because a) I think this is a horse that has already been flogged to death, and b) there's really not much Intel can do about it - aside from taking what little share AMD (NASDAQ:AMD) may have left to give. Intel basically "is" the PC chip market so as it goes, so will Intel.

More concerning from an investor's perspective is the fact that Intel management simply isn't delivering on their promises for growth in non-PC areas, which should be under their control. Industry overcapacity in NAND has led to their Memory business posting negative operating margins. Although some of this is related to startup costs, it seems at this point that the "this time it's different" thesis around Micron (NASDAQ:MU) and the broader industry has blown up - it will continue to be a feast-or-famine, boom-and-bust cycle. While Memory is a relatively small part of Intel's business, it's thus hard to judge if the returns on capital here will be worthwhile.

The Internet of Things division delivered decent results in the quarter, up double digits, but it's coming off an easy comp - the division only grew 7% in 2015 (while the broader Internet of Things market almost certainly grew much faster). Progress in mobile chips also continues to be relatively slow. While Intel is rumored to have won the second-source slot for the iPhone 7 modem, this is hardly sufficient payback for the Infineon acquisition years ago (or the rest of Intel's costly mobile development efforts).

Finally, and perhaps most frustratingly, the Data Center Group - which is going to be the biggest single driver of operating profit growth - can no longer credibly be considered a teens growth business as it has been portrayed. After growing only 11% in 2015, it grew at around 8% in the first quarter of 2016, if you choose to adjust for the extra week. While this is hardly cause for alarm, in context of the PC market declining faster than expected, it does mean that revenue growth will be more challenging for Intel to come by than it would be if DCG grew at a mid-to-high teens clip.

Why All The Restructuring?

Beyond the somewhat disappointing financial results, the headlines over the past few months - significant executive turnover, and then the sacking of a tenth of the company's workforce - are somewhat confusing. Intel management talked on the call about "accelerating our strategic transformation," but then what exactly is it that they've been doing over the past few years?

Indeed, the real challenge has been that Intel's growth in non-PC areas just hasn't been fast enough to offset the declines. The company, as it pointed out on the call, has grown revenues 5% since 2013 despite the PC market declining 10%, but low single digit revenue growth is not going to make shareholders happy (nor is it a good performance in light of the opportunity set available).

Results now are obviously a function of decisions made quarters or years ago - the design and manufacturing process takes time. The concern isn't so much financial here - in fact, the restructuring, net of assumed reinvestments, should lead to a bump in earnings - but rather strategic. Throwing more money and people at a problem doesn't solve it, but Intel's results over the last few years suggest that maybe they should be investing more - rather than less - in emerging technology segments and their non-PC business, although being quicker to pull the plug when it becomes clear that an area (like mobile chips) just isn't going to yield the financial or strategic benefit originally expected.

For example, while I'm not as concerned about the length of Intel's process lead over competitors as some analysts are, it's undeniable that the 14nm has been a big source of headaches (leading Intel to break their traditional two-year tick-tock cadence). I realize that it's much easier to be an armchair analyst here than it is to, you know, shrink wafers and all that. But that being said, it's not immediately clear that the solution to Intel's challenges is to use less resources rather than more.

The Bottom Line

I don't think Intel shareholders need to be in a hurry to sell here - earnings could actually improve a decent chunk over the next few years thanks to the transformation savings (notwithstanding performance in emerging growth areas). With shares paying a good dividend and trading at a below-market multiple, there doesn't really appear to be a big downside case here. Still, bulls - me included - have consistently underestimated the rate at which PC demand would decline, and I think at this point it's time to throw in the towel on that issue.

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.

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Tagged: , Semiconductor - Broad Line, Earnings
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