Intel Q1 2023 Earnings: Brace For More Turbulence Ahead
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Summary:
- Intel Corporation reported better-than-expected Q1 results along with a guide for modest improvements in the current quarter that beat estimates.
- However, expectations for continued double-digit declines at Intel, paired with continued cautious industry commentary over the near-term semiconductor demand environment, are dampening earlier optimism for a 2H recovery.
- There remains insufficient structural evidence supportive of respite for Intel’s fundamental struggles over the near term.
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Much of the market’s optimism priced into Intel Corporation (NASDAQ:INTC) valuation this year was based on the anticipation for new hardware shipments – including the long-awaited Sapphire Rapids which started shipping earlier this year and its successor, Emerald Rapids, which will begin shipping in the second half – to ramp up. A broad-based market rotation into the tech sector during the first quarter due to jitters in the financial sector, alongside momentum in generative AI, has also led to gains in the Intel stock this year.
However, the rally is rapidly losing steam. And despite better-than-expected earnings results released for the first quarter and a guide for modest improvement over the near term, they seem to indicate management’s earlier optimism for a 2H23 recovery remains out of reach, which we had previously raised as a potential concern. Specifically, management’s pivot to caution over looming macroeconomic uncertainties in its latest commentary, instead of a tone of outright optimism for a second-half recovery observed earlier this year, is in line with warnings by industry peer Taiwan Semiconductor Manufacturing Company Limited (TSM, “TSMC”) earlier this month as inventory levels remain elevated:
3 months ago, we said we expect fabless semiconductor inventory to start gradually reducing 4Q 2022 and we forecast a sharper reduction throughout the first half of 2023.
However, due to weakening macroeconomic conditions and softening end market demand, fabless semiconductor inventory continued to increase in the fourth quarter and exited 2022 at a much higher level than we expected. In addition, the recovery in end market demand from channels reopening is also lower than our expectation. Therefore, the fabless semiconductor inventory adjustment in first half ’23 is taking longer than our prior expectation. It may extend into third quarter this year before rebalancing to a healthier level.
Source: TSMC 1Q23 Earnings Call Transcript
While we remain cautious on the macroeconomic outlook, we are focused on what we can control as we deliver on IDM 2.0: driving consistent execution across process and product roadmaps and advancing out foundry business to best position us to capitalize on the $1 trillion market opportunity ahead.
Source: Intel 1Q23 Earnings Press Release
First, on the macro. We expect macro weakness to persist at least through the first half of the year with the possibility of second half improvements…We see potential for market conditions to improve faster than typical seasonality as third-party data shows macro headwinds easing in the second half of the year.
We remain incrementally cautious given recent signs that Intel might be off to a modest start in regaining its grip on recent AI momentum as well, due to the delayed roll-out of Sapphire Rapids. Related risks are corroborated by recent sentiment checks that indicate a pullback in orders for the Sapphire Rapids server processors across the supply chain despite resilience in high-performance computing (“HPC”). This is consistent with our concerns over Intel’s continued struggles in stemming the ever-widening performance gap with rival products.
And despite progress, Intel’s still-weak financial performance – corroborated by continued acceleration in y/y declines and margin contraction – leaves insufficient evidence that its roadmap is gaining any marked structural improvement. Meanwhile, the guide for near-term improvements to recent declines towards the range of -18% y/y to -25% y/y in sales during the current quarter also suggests the company’s struggles still in finding its grip amongst the rising competition, as well as a challenging macroeconomic environment. This puts expectations for a potential return to growth in the second half out of reach still. Although it is no secret that Intel’s IDM 2.0 strategy will be a long and treacherous one, with results not expected until further down the road, recent headwinds to the ramp-up of new technologies such as Sapphire Rapids is likely to dampen sentiment further for the stock and keep investors incrementally cautious over recent optimism on signs of modest improvements. While Intel’s current valuation discount to peers has likely already factored into consideration the elevated execution risks ahead pertaining to IDM 2.0 (admittedly, the bar’s been set low), as well as the broader impact of ongoing cyclical weakness facing the semiconductor sector, the lack of evidence supporting structural progress on the chipmaker’s roadmap accordingly increases its vulnerability to market weakness ahead.
2H Recovery Likely Remains Out Of Reach
While execution risks pertaining to Intel’s IDM 2.0 strategy are no surprise – especially after multiple delays in ramping up new technologies, which have likely tempered market expectations on the extent to which and when the chipmaker can claw back on lost market share from rivals – we remain incrementally cautious on Intel management’s optimism for a recovery in the second half. Tepid performance in the first quarter and signs of slow demand still in end-markets continue to imply that earlier expectations for a second-half recovery in the broader semiconductor sector may have been premature and could potentially dampen investors’ confidence in the stock further.
On one hand, macroeconomic challenges look to be worsening further based on recent industry and economic data. End-market demand remains acutely impacted, as observed in the steep acceleration of PC shipment declines over the past 12 months. Specifically, PC shipments have fallen by 28.5% y/y during the first quarter, marking the worst quarterly decline since the mid-1990s. And with inventory correction efforts across the supply chain still underway amid macroeconomic uncertainties that have weighed on both retail and enterprise purchasing decisions, the demand environment for Intel’s client computing offerings is not expected to return to growth until at least 2024.
The tempered expectations for potentially worsening financial conditions ahead are consistent with tones of uncertainty from Intel’s peers that have reported earlier this month. In addition to warnings from TSMC as discussed in the earlier section, Texas Instruments (TXN) has also noted continued weakness “across all end-markets” and “avoided saying whether the current chip slump has reached a low point,” as stockpiles across the supply chain remain elevated. Chip manufacturing equipment maker ASML Holding N.V. (ASML) has also noted “mixed signals on demand from the different end-market segments as the industry works to bring inventory to more healthy levels.”
The industry observations are consistent with growing signs of protracted consumer weakness based on recent economic data. In addition to a second consecutive month of declining retail sales in March, with decelerating spending on credit and debit cards as household savings tumble, the Fed’s latest Beige Book report also found consumer spending to have stayed “flat to down slightly.” This is consistent with signs of loosening in the labor market – a corner that has stayed relatively resilient over the past year despite tightening financial conditions – with ensuing declines in employment and income likely to weigh further on savings and, inadvertently, consumption over the coming months. Paired with persistent inflationary pressures and elevated borrowing costs, the macroeconomic backdrop continues to exhibit a challenging demand environment that has yet to bottom out, which could potentially thwart Intel’s ambitions for a second-half recovery.
In addition to cyclical headwinds, Intel is also facing company-specific challenges to its roadmap. On the product front, multiple delays on ramping up the Sapphire Rapids server processors – which only began shipping earlier this year – have been one of the first critical misses since the execution of Intel’s IDM 2.0 strategy. Years of delays in launching Sapphire Rapids now have the chips “shipping into an industry-wide downturn,” missing out almost completely on peak demand. And plans to regain market share appear to be severely thwarted by a weaker-than-expected demand environment, as corroborated by recent reports that key customer Microsoft Corporation (MSFT) has slashed orders for the chips. This is in stark contrast to management’s optimism from just a month ago that Sapphire Rapids will be “one of (Intel’s) fastest ramping if not (the) fastest ramping product that (it has) ever had.”
Specifically, Microsoft has continued to pour significant investments into the development of supercomputers required to run increasingly complex workloads like those required by OpenAI’s continued research in generative AI. The infrastructure for ChatGPT’s integration into Bing alone has cost $4 billion, with substantial incremental investments ahead to facilitate the continued development of generative AI-enabled productivity software (e.g., Copilot) and cloud-computing solutions offered at Azure. And with Microsoft – a leader in the ongoing development and deployment of generative AI technologies – potentially replacing some of its demand for Sapphire Rapids for rival offerings, Intel’s plans to rely on the nascent trend as a catalyst for driving growth in its business faces substantial risks.
Sapphire Rapids will support and be from a CPU perspective I think an important part of the product offering and for AI. And then we also have our own graphics product road map. And to the extent that it requires that level of compute the parallel compute then we’ll have offerings as it relates to that. So I think AI, of course, is super helpful to help drive the business, drive the growth rate and create a catalyst for it.
Source: Intel Corporation Management Presents at Morgan Stanley Technology, Media & Telecom Conference, March 2023
Admittedly, even with the anticipated start of shipment on Emerald Rapids later in the year, followed by Sierra Forest and Granite Rapids in 2024 – which Intel regards as a critical inflection that will “make a meaningful difference in terms of (its) competitive position” – we remain cautious given the related technologies might to some extent remain inferior to existing and upcoming rival offerings. And Intel’s recent unveiling of Clearwater Forest, which will be based on the Intel 18a process node technology with competitive performance against TSMC’s 3nm process, is unlikely to start shipping until mid-decade, leaving room for execution risks still when it comes to stemming its “falloff in market share.”
Implications for Intel
Intel’s modest financial performance improvements observed in the first quarter, and the anticipation for further weakness over the near term despite its better-than-expected guidance, considering the combination of macro-driven and company-specific challenges continue to underscore a lack of concrete evidence that the company is on a structural path to recovery. With both consumer and enterprise spending for hardware expected to stay muted in the current year – especially in the devices segment which is expected to see a 5% decline in demand – Intel’s aim for a second-half recovery remains to be seen. And the chipmaker’s struggles in riding on the coattails of generative AI momentum, as evidenced by potentially weaker-than-expected demand for Sapphire Rapids, will likely temper its share of more resilient IT spending “for cloud and digital transformation” despite the cyclical downturn.
Although Intel’s reiterated guide for achieving annualized cost savings of $3 billion this year will help preserve margins amid a challenging macroeconomic backdrop, related optimism has likely already been priced into the stock at current levels, and is unlikely to do much incrementally on restoring investors’ confidence. Taken together with our concerns over a potentially pushed-out timeline on the anticipated cyclical recovery due to continued economic deterioration weighing on end-market demand, there is little durability to Intel Corporation’s fundamentals within the foreseeable future, which risks translation into potentially weaker valuation prospects ahead. Despite the stock’s discount to peers, there is much credibility left for Intel to restore, and that includes continued delivery of consistently structural evidence that IDM 2.0 is progressing favorably.
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