Intel (INTC -1.68%) stock rallied after a better-than-expected rebound in third-quarter 2023 sales, and shares are now up over 25% in the last 12-month stretch. Don't get too excited just yet, though. Intel is still underperforming the iShares Semiconductor ETF by a decent margin.
Data by YCharts.
There's a good reason for this underperformance. Intel is finally making some progress, but it isn't out of the woods yet. One key financial metric is still a big red flag.
Bleeding cash at the wrong time
A rebounding PC market is fantastic news, especially since it's Intel's most important segment now that Nvidia is gobbling up new data center infrastructure share and Intel is de-emphasizing other non-core units like its programmable and networking chips. The "Client Computing Group," which houses the PC chip business, was down just 3% year over year to $7.9 billion in Q3 2023, and up nicely from $6.8 billion in the second quarter of 2023.
Resulting quarterly GAAP and adjusted net income stayed in positive territory ($300 million and $1.7 billion, respectively), a good improvement from steep losses that were persistent through the start of 2023.
But that doesn't tell the whole story, though, as neither GAAP nor adjusted income account for the large capital expenditure bills (or capex, spending on property and equipment) Intel is racking up to retool its manufacturing processes to catch up to industry leader Taiwan Semiconductor Manufacturing. When subtracting capex from the equation, resulting free cash flow was negative $20 billion through the first nine months of 2023.
Intel has been able to raise cash from various sources to spend on new property and key equipment needed for next-gen chipmaking. However, the negative free cash flow has still done a number on the balance sheet. The company is well funded with $25 billion in cash and short-term investments (it was $28 billion at the start of the year). But total debt has ballooned to nearly $49 billion (compared to $42 billion at the start of the year).
With the U.S. Federal Reserve keeping interest rate hikes in place and indicating it wants to keep them higher for longer, Intel has taken on a sizable burden of debt at the wrong time -- with an unknown payoff at some point down the road from its revamped manufacturing business. At some point, higher interest expenses are going to bite. And with lots of capex still needed in the coming years for expansion in the U.S. and Europe, free cash flow could remain minimal at Intel for quite some time.
Tread carefully with Intel stock
That being said, I have warmed up to the idea of betting on an Intel recovery, and not just because another big leading-edge chip foundry is much needed for the global economy. It seems Intel has (finally) begun making gradual steps toward a more radical shake-up of its business to free up the funds needed to pay the bills and return to sustainable earnings growth. Creating some barriers between its chip design departments and its chip fabs was one good step in my mind.
Given the free cash flow and debt situation, I'm still leery of Intel stock. The share price rally in the last year seems to already be pricing in a gradual recovery of the business, but not adequately pricing in risks to Intel's progress on returning to long-term sustainable free cash flow and earnings growth. The stock trades for 19 times Wall Street analysts' expectations for 2024 earnings per share, but initial expectations are still for negative free cash flow next year.
Given all the construction on new manufacturing facilities going on, I agree with the general consensus.
Don't get me wrong, I'm not betting against Intel, and I'm certainly not predicting some sort of total downfall. However, the company's revamped efforts don't automatically make it a great long-term bet, either. So at this juncture, the big red flag that is free cash flow is keeping me away. In the meantime, there are other great chip companies that are profitable on all counts and gearing up for more growth in 2024.
