Chip giant Intel (NASDAQ:INTC) has long talked about how its long-term revenue growth target for its Data Center Group (DCG), which sells processors and related components into server, storage, and networking applications, is in the "low-double digit" percentage range. 

The growth rate of DCG is important to watch because this segment is expected to be the company's main growth engine for years to come.

A wafer of Intel data center processors.

Image source: Intel.

The company struggled to hit its DCG revenue growth goal in 2016, in which DCG saw just 7.5% revenue growth, but the company achieved that goal in 2017. Even more encouragingly, DCG looks solidly on track to meet or even exceed that goal after it reported 24% year-over-year growth in DCG during the first quarter of 2018. 

Let's dive deeper into the hugely impressive performance of this business.

Strength across the board

Intel views its DCG business in the context of three large end customers: cloud service providers, communications service providers, and traditional enterprise and government customers.

Intel said that sales to cloud service providers grew by a stunning 45% last quarter, and its growth in sales to communications service providers surged 33%. These segments have been sources of growth for DCG for quite some time, so the strong growth isn't entirely unexpected, but it's good news nonetheless. 

Perhaps the most surprising part of the DCG results, though, was the company's performance in the enterprise and government sector. This is a segment that Intel had told investors to expect to to decline over the long term (in fact, such declines served as significant headwinds to DCG's overall growth in recent years). This segment grew by 3% last quarter. That's not a ton of growth, but it's a big deal when it makes up a large percentage of overall DCG revenue and it was previously forecast to decline. 

Huge profit growth

Last quarter, DCG saw operating income grow 75% year over year from $1.49 billion to $2.6 billion. $870 million of that growth came from higher gross profit thanks to increased chip sales, $115 million came from lower factory start-up costs associated with its 10nm manufacturing technology, and $130 million came from "other" (I suspect that this is due to yield rate improvements on the company's 14nm technology as well as increased sales of non-processor components). 

As a result of this huge growth, DCG is now generating nearly as much profit as its Client Computing Group (CCG), which mainly sells processors and related components for personal computers. It's not hard to envision that by next year, Intel's DCG will generate more operating profit than CCG does (though CCG should still generate more revenue over the next few years). 

Growth to continue in Q2, but could slow soon

According to Intel CFO Bob Swan, the company expects the kind of strength that it saw in DCG during the first quarter to continue into the second quarter of the year. However, for right now, Swan expects a deceleration in the growth rate during the second half of 2018.

That expectation, the executive said, is based on two things. Firstly, the year-over-year comparisons become harder since Intel's DCG grew much more slowly in the first half of 2017 than it did in the second half of 2017 (7.2% and 13.6%, respectively), setting the bar higher in the second half of 2018 than it was in the first half of 2018. 

Secondly, Swan expects the competitive environment to get tougher in the second half of 2018, which could lead to either market share loss or average selling price reductions -- both phenomena that would curb DCG's revenue growth rate. 

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