Why It’s Time to Conduct a Reality Check on Intel

Intel's chances of a turnaround seem to be getting dimmer every passing quarter

Jan 22, 2014 at 1:00PM

Chip manufacturer Intel's (NASDAQ:INTC) recent performance during the fourth quarter seemed like a complete reversal of the high expectations set by the company at the recent Consumer Electronics Show at Las Vegas. While the company's revenue rose 2.6% on a year-over-year basis to $13.8 billion, net income went up by 6.4% to $0.51 per share, narrowly missing Street estimates of $0.52 per share.

However, what really pulled down Intel's share price by a substantial 4.7% was its relatively flat revenue guidance for the whole of 2014 even as analysts were expecting some projections of growth. That is certainly not a good sign for a company that continues to derive a majority of its revenue from sales of chips for the fast-fading PC industry.

And with research firm IDC predicting worldwide PC shipments to fall by a further 3.8% in 2014, it's probably time to find out whether Intel is truly nearing the end of the road.

The thickening storm clouds
The bad news doesn't end there for Intel, as the company's server chip division, the only previous bright spot, reported a meager 1% rise in unit sales. Intel has even gone ahead and lowered its revenue projection for that division to 10% from an earlier high of around 15% for this year, acknowledging that it might have 'overestimated' the initial demand. In any case, while server chips do yield more profits than those for PCs, they are no match in terms of volume sales.

And the wheels are not moving
The slowdown in chip sales has also resulted in under-utilization of manufacturing capacity, something that may have forced Intel to indefinitely postpone the opening of a brand new chip manufacturing facility or 'foundry' in Arizona. Of course, part of this is also due to the management's revised strategy to trim capital utilization expenses in the wake of the decline in demand.

Although Intel is trying its best to counter this problem with its plans to open its foundries to other chip manufacturers and potential competitors, it has not roped in any major customer after Altera. That may be because the company is finding it hard to woo customers from Taiwan Semiconductor (NYSE:TSM), or TSMC, the planet's biggest contract chip manufacturer.

Having around 50% of global market share, TSMC has also planned massive investments worth a whopping $27 billion into newer technologies and capacity expansion. And the company is confident enough to expect both revenue and profits to go up by a minimum of 10% in 2014. On the other hand, Intel is traditionally perceived as a PC chip manufacturer, something that lessens its chances of success even more in the market.

The dismal mobile devices scenario
Intel's disappointing performance in the smartphone chip manufacturing arena remains pretty much the same, as evidenced by its embarrassing less-than-1% share of the global mobile processor market. The company's 'other architecture operating segments' division or the one that makes chips for smartphones and tablets, posted an operating loss of $620 million in the fourth quarter compared to $495 million during the same period last year. This makes it clear that Intel's core operations in this segment are not running the way they should be.

The competition, however, is having a field day. Rival Qualcomm (NASDAQ:QCOM) dominates more than 90% of the mobile chip market, apart from being a clear leader in the area of manufacturing LTE-enabled chips for over two years now, enabling it to remain generations ahead of companies such as Intel. With over 97% share of global LTE-based revenue, Qualcomm is now aggressively focusing on the low-end LTE-enabled chip segment, in a bid to gain more share in emerging markets such as China. While Intel is trying to enhance its presence in the low-end chip segment with products such as SoFIA, the gap with Qualcomm just seems way too much.

Some Foolish final thoughts
With PC shipments expected to continue to decline, following a temporary boost due to Microsoft's planned phase-out of the Windows XP OS, Intel's bread-and-butter business is as good as gone. On the other hand, its strategy of producing low-end smartphone chips is likely to put pressure on gross margins, as such chips are much less profitable than those for PCs and servers. And declining gross margins should be a distinct point of concern for believers in this company.

At the same time, with consumers yet to warm up to the idea of wearable devices even in developed markets, manufacturing chips for such products is unlikely to become the life saver that Intel hopes it'll be, at least in the near term. As things stand, this stock is unlikely to get a boost anytime soon, and it's probably best to let go of a large part of it from your portfolio.

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Subhadeep Ghose has no position in any stocks mentioned. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel and Qualcomm. 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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