It's earnings season, and that means a fresh round of quarterly reports from corporate America to digest. On Jan. 15, chipmaker Intel Corporation (INTC 1.77%) took its turn, reporting Q4 and full-year numbers. Intel, the largest semiconductor company in the world, did very well last year. It recovered in its key PC division, and is enjoying rapid growth in other areas such as data centers and the Internet of Things, or IoT.
Not everything is going perfectly, though. Intel gave a disappointing outlook for the first quarter, which caused the stock to fall immediately after reporting; the stock closed Jan. 22 above where it closed Jan. 14. Fortunately, Intel sees a recovery in the latter portion of 2015. And Intel is making progress in its struggling mobile business. Because of this, if everything goes according to plan, Intel is likely to have another good year in store for investors.
Recovery in the PC market fuels a strong year
First, a quick recap of Intel's report. Revenue increased 6% in both the fourth quarter and in 2014. Earnings rose 22% thanks to higher margins. Gross margin totaled 63% last year, up nearly four percentage points from the year prior. Intel's rising revenue was due partly to the stabilization in the personal computer market. Heading into 2014, Intel expected revenue in its flagship PC division, which accounts for almost two-thirds of its total revenue, to be down by low single digits on a percentage basis. Instead, PC revenue grew 4% thanks to a recovery in PC sales. Intel reported PC Client Group revenue of $34.7 billion in 2014.
Another area of growth was Intel's booming data center and Internet of Things groups. IoT is a technological advancement in which all kinds of devices are connected. Mobile, home, and embedded devices could all be connected to the Internet to integrate computing abilities. This would allow all these connected devices to share data over the cloud.
Revenue in data centers grew 25% last quarter for Intel, which made it Intel's fastest-growing business. Intel's data centers segment is now a $14 billion business by annual revenue and is Intel's second-largest division after PCs. The IoT segment grew revenue by 18% last year. Intel reported Internet of Things Group revenue of $2.1 billion in 2014.
Higher near-term costs weigh, but full-year margins should be fine
Intel's gross margin in the fourth quarter was 65%, up three percentage points year over year. But investors shouldn't get too excited about this, because Intel benefited from costs that simply got pushed into the first quarter. As management stated on the conference call, Intel predicts 60% gross margins in the first quarter, which fell approximately one percentage point below the average analyst expectation.
The main reason for this is because Intel will incur high start-up costs associated with production of its 14 nanometer Broadwell processors. Intel expects the higher start-up costs to only be temporary, and costs for the 14-nanometer products should eventually mimic those of prior technologies. Intel forecasts full-year gross margin at 62%, which would be comparable with the prior year.
Unfortunately, continued losses in Intel's mobile operations threaten its gross margins. But management is taking necessary steps in that side of the business.
INTC Gross Profit Margin (TTM) data by YCharts
Margins are important, because as you can see, Intel's valuation over the past year is correlated with its improving gross margins. Intel's significant rally since 2013 is closely tied to its gross margin. Reducing costs in mobile is critical for Intel, and it's a great sign for shareholders that management is seriously attempting to turn a profit in mobile.
Turnaround in mobile takes another step forward
At the beginning of 2014, Intel laid out its goal to get its chips into 40 million tablets by the end of the year. This was in response to rising fears that Intel was too closely tied to the PC, which would have handcuffed the company if smartphones, tablets, and other mobile devices eventually replaced personal computing. Intel did accomplish this, and then some. Intel shipped 46 million tablets last year, but this production turned out to be a double-edged sword. This production was not profitable, and resulted in widening losses. Intel lost $4.2 billion in mobile last year, up from $3.1 billion the previous year.
Thankfully, Intel should realize significant cost savings in mobile due to its decision to no longer extend significant rebates to device makers that purchase its SoFIA chips. Previously, this created "contra revenue," which then deducts from Intel's true revenue generation. For example, revenue in Intel's mobile communications group declined 85% to just $202 million last year. Moreover, Intel actually generated negative $6 million in mobile revenue in the fourth quarter. Not extending rebates, along with other measures, could fuel $800 million in cost reductions this year, which will help accelerate the turnaround in Intel's flailing mobile business.
2015 is likely to be another successful year
Intel's stock did very well last year, up 40% versus an 11% gain for the S&P 500 Index. Intel should have another good year in store. Intel's PC business stabilized last year, defying fears that laptops and desktops were going the way of the buggy whip in the smartphone era. And Intel is growing rapidly in data centers and the IoT, which are two key growth catalysts for the future.
Even in mobile, Intel is showing important progress. It's taking positive steps to cut costs to try to reduce its massive losses in mobile, which ballooned in recent years. This will help the overall company's gross margins for the full year, and if Intel hits its targets, investors should expect another year of mid-single digit revenue and earnings growth in 2015.
