Intel Disappoints

Intel's recent earnings report is yet another mixed bag, serving to disappoint the bulls and empower the bears.

Jan 17, 2014 at 11:30AM

At the time of writing, shares of Intel (NASDAQ:INTC) are down about 5% following the company's earnings report and subsequent conference call. The quarter wasn't bad. Sales came in at $13.83 billion -- ahead of the company-guided midpoint of $13.7 billion. Gross margin was ahead of expectations -- 62% against a 61% guide. But when a stock runs up significantly on the hopes of a major "beat,"  shares are likely to take some punishment in the event that the beat fails to materialize.

The big problem with this report
The analysts, taking hints from PC supply chain results, were correct in forecasting that PCs would do better than expected. Indeed, the big surprise of this report was that desktops, of all form-factors, actually registered some pretty robust growth in units and average selling price in the fourth quarter. Notebooks, on the other hand, continued to exhibit more modest results.

However, in a rather shocking turn of events, PCs weren't the problem here. For the first time in a while, Intel saw its PC chip sales remain flat on a year-over-year basis during the quarter. It was, instead, the company's shining star -- the data-center group that provides chips for servers, cloud, networking, and storage -- that was the problem. What happened here, exactly?

Enterprise orders weaker than expected
At Intel's recent analyst day, management guided to the following:

  • 9% year-over-year growth in its data-center group, or DCG, during 2013
  • 13-15% year-over-year growth in the data-center group during 2014 from 2013 levels

However, since a good portion of Intel's data-center revenue is levered to enterprise IT, any material misstep in calling that market correctly means that guidance for the entire division is in serious jeopardy. Unfortunately for Intel investors, enterprise sales fell short, as demand fell off near the end of the quarter. This led CFO Stacy Smith to informally "guide down" for the data-center group to about 10-12% revenue growth in 2014 instead of 13-15%.

What now?
Given that DCG is Intel's crown jewel from a gross-margin perspective, investors are unlikely to be happy, particularly as it's up to DCG to help offset the mounting losses in the "Other I" division, which is Atom, Infineon, etc. That being said, while this may seem negative, it's important to keep in mind the following things:

  • Intel guided to $12.8 billion -- plus or minus $500 million -- during the first quarter of 2014, which is actually an increase from $12.6 billion during Q1 2013.
  • In addition to a slight year-over-year bump in revenue during the first quarter, Intel guided for a 59% gross margin for the quarter, up nicely from 56% in the year-ago period. Intel also seems to be lowballing the gross margin, meaning investors could see it hit as high as 60% during Q1 2014.

While it's still too early to tell, Intel doesn't need to do much in order to actually get to that flat guidance for 2014. However, a lot really depends on the state of the PC market as it progresses, Intel's ability to take share, and the trend in the data-center group. While competitive threats aren't the issue for DCG, the underlying end markets certainly are.

Intel needs to get into mobile ASAP
It is imperative that Intel move very quickly into the tablet/smartphone chip space. With the PC end markets still uncertain at best, and with the data-center group not providing the robust growth that management has tried to sell for years, it's clear that there's no more time to lose in these markets. 

Some say that Intel should simply be a foundry, in the vein of TSMC (NYSE:TSM). Unfortunately, while Intel does want to take more of the semiconductor business from TSMC, it remains to be seen how a company optimized to be an integrated device manufacturer can compete with a company that lives and breathes foundry work. TSMC's recent earnings call was extremely bullish, particularly about its 20-nanometer ramp. The company was quite clear that at the 16-nanometer node, it has won the vast majority of the high-end semiconductor business.

Given that most of TSMC's growth has come from mobile chips, and given that TSMC doesn't profit as nicely on these chips as its customers do, it makes sense for Intel to put foundry ambitions on the back burner and to really go all-in on taking share from TSMC's customers like Qualcomm and NVIDIA. This is the only way, at this point, that Intel becomes a truly viable growth story.  

It's not doomsday for Intel, but it's tough to see any positive catalysts at least over the next quarter. What investors need to realize is that from the perspective of revenue, mobile isn't material to Intel for another year, so all eyes are on PCs and the data-center group. Further, the design-win momentum Intel gets with tablets this year will help paint a clearer picture of what sort of revenue to expect next year, when the contra revenue on mobile parts is no longer needed.

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Ashraf Eassa owns shares of Intel. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel. 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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