Intel: Road to recovery is long (NASDAQ:INTC)

Introduction and thesis

At the end of January 2024, we initiated coverage Intel Corporation (NASDAQ: INTC) with a “Hold” rating and recommended avoiding the stock as Intel’s business appeared to be an obvious laggard compared to other tech peers. sense. After the share price fell by 28% – this happened in the end of May 2024 – I decided to upgrade the stock to “Buy” because we believed that INTC’s Gaudi 3 would have a long-term competitive advantage, especially in enterprise AI applications where efficiency and profitability are critical. My DCF model at the time showed an 18% undervaluation – that’s how much the stock has risen since that bullish call of mine before the second quarter results came out, and INTC lost over 30% in a few days.

Today, I would like to review my rating again and downgrade it to “Hold”. From a valuation perspective, I think INTC is no longer an unconditional “buy” for investors looking for a sufficient margin of safety. As a serial underdog (in my opinion), Intel seems to have enough internal issues that could cause today’s correction to continue.

Why do I think so?

As usual, I aim to start with an analysis of the latest quarterly report, which was essentially the trigger for the share price crash that has continued to date.

Intel’s Q2 FY2024 performance looked pretty bleak, with revenue of $12.83 billion, up 1% sequentially, down 1% year-over-year and below the midpoint of management’s guidance of 12.5-13, $5B and the consensus estimate of ~$12.98B. Non-GAAP EPS was $0.02, down significantly from $0.13 a year earlier and below expectations of $0.10. In fact, what we saw recently was the worst loss of earnings in the company’s history, at least in the last few years, according to Seeking Alpha:

Clearly, Intel has faced real difficulty maintaining profitability amid competitive pressures and strategic investments—even CEO Pat Gelsinger described the quarter’s profitability as disappointing (during the earnings call) despite progress in the spreadsheet. path of products and processes:

Q2 profitability was disappointing despite continued progress on product and process roadmaps. With our new operating model firmly in place, we are accelerating actions to improve profitability and capital efficiency by over $10 billion in 2025, which I will discuss shortly.

For the quarter, we saw sequential revenue growth in line with our forecast, despite the unexpected timing of the new export control restrictions announced in May. Profitability in Q2 was below our expectations, in part due to our decision to accelerate the core Ultra AI CPUs faster, as well as other selective actions we took to better position ourselves for future quarters , which Dave will cover fully in his comments.

We know from the comments that during the second quarter, Intel focused on its aggressive node and product roadmap, especially in the Client and Data Center segments. However, the company acknowledged that it “faces a long road to recovery” with stiff competition from Advanced Micro Devices ( AMD ), Nvidia ( NVDA ), Apple ( AAPL ) and others. Apparently, the huge competition caused Intel to move production of its newest PC processors from a low-volume/lower-cost factory in Oregon to a high-volume/much higher-cost factory in Ireland, so its gross margin missed significantly in T2.

Intel has moved production of its latest PC processors from a low-volume (but lower-cost) factory in Oregon to its high-volume (but for now much higher-cost) factory in Ireland. Intel believes this was the right change in the long run, but we fear that Intel rushed this processor (formerly codenamed Meteor Lake) into prime-time production in the face of intense competition for AI computing, perhaps speaking to the lack of relative competitiveness. of previous generation CPUs.

Source: Brian Colello on Morningstar (proprietary source, August 2024)

As already mentioned above, Intel’s restructuring actions should aim to improve profitability and capital efficiency by more than $10 billion by 2025, mainly due to OPEX, COGS and CAPEX reductions. The company is also cutting its workforce by more than 15% by the end of 2024. However, Intel also faced gross margin headwinds in the second quarter due to the accelerated launch of Core Ultra AI processors and unexpected costs to be raised in non-core businesses. , so I can’t see where they will save on COGS (at least at this cost) in 2025. Additionally, as Argus Research analysts noted in their post-earnings report (proprietary source, August 2024), the new restrictions on import controls have affected Intel’s earnings timing – a continuation of this impact may continue to pressure margins going forward.

In addition to weak earnings, the sharp decline in share price was a consequence of management’s rather pessimistic guidance for Q3 2024, which now suggests a challenging second half of the year, with expectations of annual revenue declines of 5%-12% and a non-GAAP loss. Of course, such a development couldn’t help but lead to massive revisions to sales and earnings per share forecasts well beyond Q3:

Despite these challenges, Intel is nearing completion of its “five nodes in four years” project, with the Intel 20A product starting production in the second half of 2024. On the other hand, it is far from certain that this initiative will help INTC. to stand out among his peers. The company is also preparing for the launch of its 18A process node, with products such as “Panther Lake” and “Clearwater Forest” expected to reach mass market status in 2025. But again, the competition is still there, so that there is a risk to Intel. that even if its designs make it to market, pricing pressure won’t go away and Intel’s profit margin will continue to suffer.

As the company focuses on expanding Intel Foundry Services (IFS) with the goal of becoming the second largest external foundry by 2030, I believe that the overall business model that Intel operates has some vulnerabilities that could limit its growth and profit margins. I draw this conclusion based on the comments of a former Intel manager who shared his opinion about the Tegus platform (basically they interview experts to gather information for institutional investors). I found part of that interview on X, and while I have no doubts about its authenticity, I have to make a small disclaimer about how I found this material.

I’m not a big expert in the semiconductor industry, but from what I understand, I can draw some brief conclusions. First, TSMC ( TSM ) has gained a significant cost advantage over INTC over the years. This advantage is due to its aggressive programs with equipment suppliers to increase productivity and improve performance, with which Intel has struggled to keep up. Second, TSMC has had a technological advantage since switching to FinFET technology around 2011-2012, while Intel, on the other hand, has failed to make similar technological advances in this regard. Third, TSMC has always been able to manage and implement new process technologies efficiently in the past, while Intel has struggled to replicate this efficiency, particularly in the US.

So one of the few strengths of INTC stock is still its low valuation: while most other semiconductor stocks maintain valuation premiums that allow their share prices to continue to rise as the financials expand, Intel’s valuation profile becomes more and more attractive (at least at first glance):

Why do I write “at first sight”? First, forward GAAP P/E of 89x does not look attractive at all, and FWD growth rates do not bode well, which fully justifies the presence of a valuation cut:

Moreover, after a sharp increase in INTC’s valuation in 2023, the stock has yet to reach its historically normal EV/EBITDA levels, which should be in the 7-8x range and not 11.4x as it is today :

conclusion

From all of the above, I conclude that my previous “Buy” rating needs to be revised down. It looks like Intel still has a long way to go and will have to work hard to restore the market’s confidence in the company’s future. However, the CEO continues to buy the dips, even though his consolidated purchase price appears to be very deep underwater:

Maybe he knows something we don’t?

I can’t answer that. But I think it’s only worth trying to buy any dip in the stock if we can see or predict with some degree of certainty when the business will turn around. In Intel’s case, despite its obvious undervaluation by several criteria, I see no end to the headwinds the company faces. Maybe INTC’s new products in 2025 will radically change the current picture – then I’ll be happy to upgrade the stock back to Buy. But not yet.

Thank you for reading!