Intel: Q3 Marks The Turning Point, Buy (Rating Upgrade)

Summary:

• Intel reported a revenue beat but a huge EPS miss due to restructuring and impairment charges.
• The company mentioned a key partnership with Amazon Web Services for next generation CPUs on built on Intel 3 and an “AI fabric chip” built on Intel 18A.
• While challenges and risks remain, I upgrade Intel to a Buy and believe this is a turning point.

Q3 Earnings Report

Intel (NASDAQ:INTC) shares are up after a decent earnings report gave investors an update on the transformation of the American semiconductor giant. Revenues of $13.28b, while down 6.2% from this quarter last year, beat analyst estimates by $240m. The company had billions in impairment and restructuring charges cause a $0.43 miss on EPS which came in at -$0.46. Intel CFO David Zinsner said “restructuring charges meaningfully impacted Q3 profitability as we took important steps toward our cost reduction goal… The actions we took this quarter position us for improved profitability and enhanced liquidity as we continue to execute our strategy. We are encouraged by improved underlying trends, reflected in our Q4 guidance.” Intel is making progress on sweeping organizational simplifications and is progressing toward delivering $10b in cost reductions in 2025. The company also expects to return to nearly a 40% gross margin with positive non-GAAP EPS in Q4 2024 with revenues between $13.3-$14.3b.

The company’s Q3 gross margin fell materially YoY from 42.5% to 15% due largely to $3.1 billion of charges, substantially all of which were related to depreciation expense for the Intel 7 process node. Excluding these charges, gross margin was roughly flat YoY at 38%. In the 10-Q, the company states that these charges were because manufacturing capacity of Intel 7 is higher than market demand for the node. Weak demand for Intel Foundry has been the defining characteristic of the company’s struggles, and these struggles were persistent this quarter.

The company’s beleaguered desktop segment declined 18% in the quarter, bringing in just over $2b, while the notebook segment grew 9% to $4.89b. Revenue from the Intel Products segment overall was slightly down due to desktop weakness, partially offset by notebook strength and slight growth in the data center and AI segment (“DCAI”). DCAI revenue grew from $3.08b to $3.35b YoY. The lack of growth in DCAI amidst the industry boom now leaves Intel securely in third place for merchant silicon providers in the US AI hardware. Nvidia (NVDA) is definitively in first and AMD’s (AMD) recent report showed their AI accelerator sales at $3.5b, placing them second. The lack of demand for Intel’s Gaudi line of accelerators underpins the importance of the company’s re-emergence as a reliable leading edge foundry partner.

The Foundry segment was also weak in the quarter, bringing in only $4.3b this quarter versus $4.7b this time last year. The only meaningful contributor to operating profit in Q3 was the client computing segment (comprised of desktop and notebook), with DCAI segment operating margin at about 10% and the Foundry segment generating a significant loss. Still, Intel is powering ahead with the five nodes in four years strategy. Progress on Intel’s fifth node in four years, Intel 18A, is “healthy and continues to progress well, and the company’s two lead products, Panther Lake for client and Clearwater Forest for servers, have met early Intel 18A milestones ahead of next year’s launches.” Further, Intel and Amazon (AMZN) Web Services (“AWS”) are finalizing a multi-year, multi-billion-dollar commitment to expand the companies’ existing partnership to include a new custom Xeon 6 chip for AWS on Intel 3 and a new AI fabric chip for AWS on Intel 18A. This marks a huge milestone for the company in finding a major external customer. Both Panther Lake and Clearwater Forest are Intel Product Group chips.

Looking Ahead

Intel sits at a crossroads right now. The company is suffering from share loss against AMD in the x86 market while Taiwan Semiconductor Manufacturing Company (TSM) is far ahead of Intel in the dedicated foundry market. AMD continues making progress in data center CPUs and GPUs and has a very competitive chiplet platform that offers customers flexibility and cost efficiency. Meanwhile, TSMC owns the vast majority of the industry’s most profitable chip manufacturing contracts while Intel works on standing up the 18A process node.

18A will be the first Intel node that is competitive with TSMC from a technological standpoint in many years. What is really promising is that Intel is working with Amazon to design and manufacture chips on the 18A process node. This will be a critical early win for the company if they can close the deal in 2025 and something that speaks to the broad-based strength of Intel’s product portfolio.

Despite current weakness in both the foundry and products segments, Intel has compelling value propositions in advanced packaging and the 18A process technology. 18A will be the first manufacturing node to feature ASML’s (ASML) high-NA EUV, backside power delivery, and gate-all-around transistors. Each of these represent key disruptions in the foundry industry and makes 2025 a turning point for chip manufacturing. Of course, 18A yields and cost will be critical, and failure is still very possible. However if there was ever a time for Intel to leapfrog TSMC it’s right now.

This report was just strong enough to warrant an upgrade in my Intel rating, from Hold to Buy. In my previous article, titled Intel Stock: Long-Term Success Seems Likely, But The Path Forward Remains Uncertain, I discussed key market dynamics in both x86 and foundry. I made the claim that AMD’s product superiority threatens Intel as AI PCs begin to rise but made many of the same points in that article as I made today. Intel’s key headwinds are its bleeding foundry segment and rapid share loss to AMD in data center CPUs. However, Intel remains at the forefront of industry innovation with the 18A process node, its advanced packaging capabilities, the early adoption of high-NA EUV, and backside power delivery. This report confirms progress and solidifies hope that 18A will be in volume manufacturing beginning 2025 with gate all around transistors and a backside power delivery network. If Intel can successfully navigate yield and cost considerations, these two innovations alone will be a catalyst to a very successful year for Intel investors in 2025.

This quarter is likely the inflection point for the company as they put major restructuring and impairment charges in the rearview mirror and look forward to ramping new process nodes and technologies. Intel stock is now worth the risk, and I recommend a Buy after Q3 earnings.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.