How Awful Will Intel's Earnings Be?

Intel (INTC 1.74%) reports today after the market close, and chances are it isn't going to be a blowout quarter. Between the estimates from Gartner and IDC, fourth quarter worldwide PC shipments fell somewhere in the range of 4.3% and 6.4% since the year-ago period. The launch of Microsoft's Windows 8 did not reignite demand that many investors were hoping for, which can be taken as negative development for Intel investors. PC demand has remained weak in the face of smartphones and tablets, an area of explosive growth where Intel has made little inroads. Intel's more energy-demanding x86 chip architecture isn't quite ready for the mobile computing revolution. As a result, ARM Holdings has filled the void by becoming the preferred chip architecture for mobile computing. Considering all of these headwinds, what can an Intel investor expect out of the company's earnings announcement today?

A brief recap

Source: Intel quarterly earnings press release. All dollar figures are in millions.

Last quarter, Intel reported a net income of $3 billion on revenue of $13.5 billion, with the consumer-facing PC market remaining its Achilles' heel. The bright spot is its data center segment. Intel secretly benefits from the sale of tablets and smartphones because they create more web traffic, which indirectly drives more sales of servers. In the past, Intel has hinted that 122 tablets or 600 smartphones is enough traffic to occupy one server. This is a very positive dynamic for Intel's data center business because it contributes to more than 25% of the company's total profit. Not to mention, these server sales help mitigate the decline Intel's PC business is experiencing.

Sinking margins?
Over the past three quarters, a negative correlation between profit margins and research and development spending has asserted itself because Intel has been investing heavily into future products. Intel's R&D budget is the highest in the semiconductor industry, giving its fabrication process a three-year lead ahead of rival Taiwan Semiconductor. By the time TSMC releases its first processor based on industry-leading FinFET technology, Intel will already be on its second generation. Longer term, Intel's big bet on its future should pay off, but in the interim, it may come at the expense of profit margins.

Outlook
In general, the analyst community is anticipating Intel's report to fall more or less in line with consensus expectations. Intel is expected to report revenue of $13.53 billion and $0.45 a share in net profit. No EPS revisions have been made since the new PC shipment data came out in the last week. The community is taking their chances, indicating that the newest round of data was in line with their forecasting.

In particular, I'm going to be watching for gross profit margin changes, data center growth, R&D expenses, and how PC group fared relative to Gartner's and IDC's fourth-quarter PC shipment data. I fully expect Intel to be talking up the future in a big way during the conference call, and I won't blame them for doing so. At the Consumer Electronics Show in Las Vegas, Intel debuted its plans for the rest of 2013, which includes chips for smartphones, tablets, and Ultrabooks (oh my!). Coming this spring the world will be introduced to Haswell, the successor to its Ivy Bridge platform, which is expected to power computing devices that are capable of 13-hour battery life. If this holds true, the jump from Ivy Bridge to Haswell will be Intel's personal best record between a single generation.

Don't panic
Intel investors should set a long-term time horizon and reap the benefits of a 4.1% dividend yield while they wait for Intel's investments to deliver a compelling mobile computing solution. Come next year, Intel will be leading the pack with its 14-nanometer fabrication process, which should make its Atom line of chips very competitive to ARM. In the meantime, Intel remains my extreme value pick for 2013.