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Here's Why Intel Could Be a Top Growth Stock in the Long Run

By Harsh Chauhan – Oct 29, 2021 at 7:10AM

Key Points

  • Despite a disappointing earnings report, there's still more to the company than what meets the eye.
  • The chip giant showed signs of improving pricing power last quarter.
  • Investments in manufacturing could position Intel to benefit from the semiconductor market's secular growth.

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Chipzilla may be down, but it is not out.

The stock market reacted negatively to Intel's (INTC -4.22%) latest quarterly results, with shares of the chipmaker losing nearly 12% following the earnings release. This wasn't surprising considering that the chip giant's third-quarter report didn't tick all the boxes, as its earnings guidance fell short of Wall Street's expectations. Intel expects its fourth-quarter earnings will drop 39% year over year to $0.90 per share, while analysts were looking for $1.02 per share. Investors also took dim view of the fact that the company's long-term spending plan that's supposed to kick-start growth will hurt profitability.

More specifically, Intel's gross margin is expected to drop 6.5 percentage points year over year this quarter. The chipmaker also pointed out that its gross margin will range between 51% and 53% for the next two to three years. For comparison, Intel's non-GAAP gross margin stood at 60.1% in 2019 and 57.6% in 2020. A lower gross margin profile points toward an erosion in Intel's earnings power, so it isn't surprising some investors were quick to sell the stock.

However, savvy investors looking to buy a semiconductor stock for the long run can treat Intel's latest drop as a buying opportunity. Here's why.

Person looking at a line chart on a laptop screen.

Image source: Getty Images.

Don't miss the silver linings in Intel's latest report

The client computing group (CCG) was Intel's biggest business segment last quarter, with $9.7 billion in sales. The segment's revenue was down 2% year over year thanks to component shortages that hampered production and hurt sales of its lower-end processors. This weighed on the chipmaker's overall non-GAAP revenue, which came in at $18.1 billion for the quarter, up 5% over last year but slightly short of the $18.2 billion Wall Street expected.

Particularly, Intel's notebook platform processor volumes dropped 14% year over year. However, the good part is that the average selling prices (ASPs) of its notebook processors increased 10% year over year thanks to an improved product mix. Intel pointed out on the latest earnings conference call that it saw "a richer mix of premium notebook products" during the period. This led to a sharp improvement in the ASP compared to the second quarter, when prices of notebook processors were down 17% over the prior year.

Additionally, the ASP of Intel's desktop processors increased 4% over the prior year, while volumes grew 16% on the back of stronger sales of its higher-end processors. Meanwhile, the data center group (DCG), which is Intel's second-largest source of revenue, also improved during the period, with ASP increasing 3% year over year and volumes jumping 8%. The DCG reported a 10% year-over-year increase in revenue to $6.5 billion -- a Q3 record -- driven by a recovery in demand from the enterprise, government, and communication service provider segments.

The Internet of Things (IoT) business also turned in a terrific performance, with record revenue of $1 billion in the third quarter, up 54% from the year-ago period as demand continued to recover in the wake of the coronavirus-fueled downturn last year. Intel is now looking to capitalize on the diverse end-market opportunities that it sees going forward, which is why it has decided to ramp up investments and keep the bigger picture in mind.

Playing the long game

Intel has outlined capital expenditures of $25 billion to $28 billion for 2022, adding that there is the "potential for further growth" in this metric in the coming years. For comparison, the chipmaker is expected to spend between $18 billion and $19 billion in capital expenditures this year.

This massive jump in spending is going to weigh on Intel's bottom-line performance, but it can also set the company up for robust long-term growth. CEO Pat Gelsinger highlighted that the management team in the short term is focusing on investing to strengthen the long-term business operations.

Gelsinger added that the launch of five manufacturing process nodes in the next four years, although they will stretch the margins presently, the manufacturing process improvements will grow the long-range margins. Intel is looking to regain its technology leadership from rival Advanced Micro Devices by launching new process nodes in the coming years that promise sharp gains in performance.

Better chips can help Intel regain its pricing power. The good part is that Intel already showed us last quarter that it can command improved prices thanks to Tiger Lake and Alder Lake chips based on the 10-nanometer manufacturing process, which brings the company at par with AMD's 7-nanometer process.

Also, Intel has broken ground on two new fabrication facilities in Arizona, three months ahead of its original plan which is an extensive component of the capital expenditures. The company is looking to add capacity aggressively, citing the rapidly growing demand for chips. It pointed out that the semiconductor industry's revenue could double to $1 trillion by 2030, so the investments in new facilities and research and development look like the smart thing to do given the bigger picture.

All told, Intel is looking to regain its mojo and seize back the market share that it has been losing to rivals. Of course, this will pressure its margins in the near term, but patient investors looking to buy a tech stock for the long run may be rewarded handsomely once Intel's investments start paying off. Given that shares are trading at just 9.6 times trailing earnings, it may be a good idea for savvy investors to buy the stock and wait patiently for a turnaround. Intel's latest quarterly results show that it can gradually switch into a higher gear.

Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Advanced Micro Devices. The Motley Fool recommends Intel and recommends the following options: long January 2023 $57.50 calls on Intel and short January 2023 $57.50 puts on Intel. The Motley Fool has a disclosure policy.

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