Intel (INTC 2.71%) stock has been on a monster rally. The semiconductor company's share price is up 225% year to date and up 498% over the past 12 months.
While the company has made some meaningful cost-cutting and efficiency moves, hopes that it can solidify itself as a long-term winner in artificial intelligence (AI) have played a much bigger role in the rally.
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The bull case for Intel
Intel has multiple ways to win in the AI megatrend. For starters, central processing units (CPUs) are in the process of taking on a far greater share of AI workloads, particularly as inference becomes a more important segment of the space. In its last quarterly update, graphics processing unit (GPU) leader Nvidia said it saw a $200 billion addressable market for AI CPUs and was moving to capitalize on it.
Intel is already a leading provider of high-performance CPUs, and that position could make it a major beneficiary of the still-growing demand for AI computing power. Because CPUs are poised to become a much bigger part of the AI hardware stack, a lot of the pressure that was previously on Intel to become more competitive in the high-end GPU market should ease up.
In addition to its chip design business, Intel also has one of the strongest positions in chip manufacturing. While third-party foundry giant Taiwan Semiconductor Manufacturing still dominates the contract chip manufacturing market globally and holds a meaningful technological edge, Intel has been making some real advances with its tech. There's also a geopolitical dynamic working in its favor: In response to concerns that China could move to exert control over Taiwan, the U.S. government, its allies, and many big tech companies have been taking steps to diversify their chip sourcing away from foundries on that island.
NASDAQ: INTC
Key Data Points
Intel has already won contracts and partnerships with Apple and Alphabet, as well as with SpaceX and Tesla's Terafab project. As such, Intel's foundry business finally looks poised for a dramatic increase in sales to third-party customers. If Intel's 14A process really winds up winning large, repeat, high-margin contracts from many of the most influential players in the tech industry, the company will justify a substantial valuation premium.
The bear case for Intel
While Intel has the potential to see some significant wins in conjunction with rising demand for CPUs used in AI infrastructure, its core chip design business is still under pressure. Intel has been losing market share in PC and server CPUs to Advanced Micro Devices, and architectures from Arm are posing real competitive threats to the company's long-dominant x86 architecture.
While Intel's revenue grew roughly 7% year over year in Q1 to reach $13.58 billion, far exceeding the average analyst estimate of $12.42 billion, the business is still facing significant competitive pressures -- and it's possible that its sales growth will be lumpy. For a company that now trades at a highly growth-dependent valuation, its recent sales growth is still far from explosive.
In addition to challenges on the chip design side, there's still significant uncertainty about the outlook for Intel's foundry business. It has notched some notable wins and has some significant factors working in its favor, but Intel faces tough competition in the chip manufacturing space -- and big questions remain about the foundry unit's path to profitability.
Last quarter, the foundry unit recorded a loss of $2.4 billion on revenue of $5.4 billion. Crucially, the vast majority of its revenue came from manufacturing Intel's own chip designs. While third-party orders seem to be ramping up, it's likely the fabrication business will continue to post big losses in the near term.
With Intel now trading at 10 times this year's expected sales and 110 times this year's expected earnings, the stock's valuation profile comes with significant risk. Even if the business continues to deliver significant wins, they may not be enough to support more gains for the stock.
