Despite the Bad News Intel Still Has Upside


In a sense, the initial market reaction to Intel's latest results tells you what you need to know about the stock. In short, the semiconductor manufacturer gave lower than expected revenue guidance, declared that its customers were cautiously keeping their inventories lean, and delayed production of a new chip due to technical issues. Yet, the stock still went up.

Intel disappoints
Intel's third-quarter revenues of $13.5 billion were in line with company guidance and its gross margins were higher, but this was far from being a positive report. Essentially, the chipmaker is trying to transition its products toward ultra-mobile PCs and mobile devices. Meanwhile, it has to deal with the usual uncertainty of its end demand that bedevils the highly cyclical semiconductor sector. There are four key takeaways from the results, and each of them highlighted Intel's current difficulties in achieving its aims.

First, the midpoint of Intel's revenue guidance for the fourth quarter implies that full-year revenue will come in at around $52.6 billion. This represents a year-on-year decline of 1.4%, when it had previously forecast they would be flat.

Source: Company accounts.

The main reasons appear to be that its customers are reluctant to build up inventory due to uncertain consumer demand. Indeed, only a day later Taiwan Semiconductor said its fourth quarter revenue could fall by 11%, due to "softer demand for certain high-end smartphones and inventory correction." This is a worrying comment given that the fourth quarter is traditionally the strongest for the industry.

Second, Intel argued that its mature markets in the US and Europe were stabilizing, while Asia and particularly China remained volatile.

The third takeaway is that production of its 14 nanometer chip Broadwell will now begin at the start of 2014, one quarter later than planned. On the conference call, management claimed that this was "a small blip in the schedule" due to a technical issue which has now been resolved.

Fourth, Intel announced that its Bay Trail processor (aimed at the entry point ultra-mobile device market) had over 50 design wins, and eight to ten of these products will be available by Thanksgiving.

What it all means: FedEx, International Business Machines, and Intel
From a macro perspective the color given on its customers' behavior was disappointing, but it's in-line with what other bellwethers have been saying. For example, FedEx has sequentially lowered its global 2013 GDP forecast throughout the year. In addition, International Business Machines recently reported weakness in China. IBM's sales were down 22% in China, with its hardware sales down a whopping 40%. IBM blamed a combination of its own execution problems, and delays in public spending caused by the wait for the mid-November release of an economic reform plan. Moreover, IBM doesn't expect Chinese demand to improve until early next year. A warning sign for Intel's fourth quarter?

With regard to its internal execution, Intel's scorecard is mixed. The technical issues with Broadwell appear to be resolved, but the delay now means that products incorporating the chip won't be available until after April. In addition, the design wins with Bay Trail are impressive, but investors could have hoped for more products to be available during the critical shopping season.

All told, it's not hard to see why the full year guidance was lowered.

But does it really matter?
The fact is that none of these developments represent significant long-term headwinds for Intel. The technical issues with 14 nanometer chip production only serve to highlight that next generation chip production requires huge resources, and very few companies have Intel's financial firepower. Furthermore, Intel is now demonstrating its commitment to penetrating the ultra-mobile device market.

Despite the fall in earnings this year, the stock still trades on a P/E ratio of 12.7 times earnings for 2013, and a dividend yield of nearly 4%. In other words, the valuation is so cheap that Intel can afford to make the odd hiccup from quarter to quarter. Moreover its near 60% gross margins and substantive free cash flow generation (approaching $9 billion on a trailing basis) mean that it can buy its way into the new device market. The company may not be firing on all cylinders, but the valuation provides for plenty of upside if/when it starts achieving its aims.

Intel isn't growing, but this company is
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Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel and International Business Machines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Originally published