Intel (INTC 0.38%) might initially seem like an attractive investment for value-oriented income investors. The chipmaker's stock trades at just 10 times forward earnings and pays a forward dividend yield of 2.7%.
Intel's insider sentiment has also improved since Pat Gelsinger took over as its new CEO in February. Over the past 12 months, Intel's insiders bought nearly twice as many shares as they sold. But during that period, Intel's stock rose just 5% as the S&P 500 advanced nearly 30%. AMD's (AMD -2.12%) stock skyrocketed more than 50%. Intel's low valuation and high yield might limit its downside potential, but four red flags could also prevent it from outperforming the market.
1. Its data center share losses to AMD
Between the fourth quarters of 2018 and 2021, Intel's share of the global x86 CPU market fell from 77.1% to 62.1%, according to PassMark Software. AMD's share rose from 22.9% to 37.7%. Intel's losses in the desktop and laptop markets were already disappointing, but its losses in the data center market -- which it traditionally dominated with its high-end Xeon CPUs -- were the most surprising.
During that period, Intel's share of the server market fell from 98.4% to 91.9%. AMD's share rose from 1.6% to 8.1%, with most of those gains occurring earlier this year. That pressure clearly indicates that AMD's EPYC chips are pulling big data center customers away from Intel's pricier Xeons. If Intel can't stop that bleeding, its data center group (DCG), which generated 34% of its revenue last quarter, could be in serious trouble.
2. Its ambitious plans to overtake TSMC and Samsung
Intel ceded the CPU market to AMD because it suffered from delays and chip shortages while falling behind TSMC (TSM 0.17%) and Samsung in the "process race" to manufacture smaller and more advanced chips. Intel manufactures its own chips, while AMD outsources the production of its highest-end chips to TSMC. So when Intel's own foundry failed to keep pace with TSMC's smaller nodes, it also lost its technological lead to AMD.
Before Gelsinger returned to Intel, his predecessor Bob Swan had flirted with the idea of becoming a "fabless" chipmaker like AMD. However, Gelsinger quickly scrapped that idea and doubled down on expanding Intel's manufacturing capabilities by investing billions of dollars into building new plants in the U.S. and Europe. Intel is also opening up its plants to third-party fabless chipmakers to compete against TSMC and Samsung.
Gelsinger believes Intel will catch up to TSMC and Samsung in the process race by 2024 then reclaim the lead by 2025. That bold claim raised a lot of eyebrows since TSMC already plans to spend about $100 billion over the next three years to expand its capacity and maintain its lead. Therefore, Intel will likely need to outspend TSMC to reclaim the lead in just four years, but it only allocated $18 billion to $19 billion to capital expenditure (CapEx) this fiscal year.
3. Its dependence on big government subsidies
Intel doesn't have enough cash to regain the process lead on its own, so it's asking the U.S. and Europe for large subsidies. In the U.S., Intel is pushing for the approval of the CHIPS act, which would grant $52 billion in subsidies to domestic chipmakers for the production of new stateside plants. Intel is also asking the European Commission to fund its development of new plants with nearly $10 billion in subsidies.
Intel claims that its plants will enable fabless chipmakers to reduce their dependence on TSMC, Samsung, and other Asian foundries. Gelsinger also argues that Chinese threats make Taiwan -- which is home to TSMC and its smaller rival UMC -- a more "unstable" region for chip production than the U.S.
Unfortunately, Intel's plan has a glaring flaw: The U.S. government views Taiwan as a crucial geopolitical ally, and it already granted TSMC subsidies for the construction of a new $12 billion plant in Arizona earlier this year. TSMC has also been urging Congress to include foreign chipmakers in the CHIPS act. If that happens, Intel's entire subsidy-funded expansion plan could fall apart.
4. It needs to suspend its dividends
Intel has already taken bold steps to raise more cash. It's in the process of selling its NAND memory chip business to SK Hynix for $9 billion, and it plans to spin off its automotive chip unit Mobileye in an initial public offering (IPO) to raise more cash. It also significantly reduced its buybacks this year.
But, Intel could free up significantly more cash by suspending its dividend, which used up $5.6 billion of its free cash flow (FCF) in 2020 and another $4.2 billion of its FCF in the first nine months of 2021. It doesn't make any sense for Intel to pay out billions of dollars in dividends while pleading for government subsidies. Intel could eventually realize that it's a bad look and suspend its dividend, but its income investors will flee.
A rocky road ahead
Intel's stock looks cheap, but these four red flags justify that discount. It's still struggling to keep pace with AMD, it's heavily dependent on future government subsidies, and it might need to suspend its dividend in the near future. Investors should stick with better-run chipmakers until more green shoots appear.