Intel’s Q4: Delusion And Intervention
Contributor since 2013 / 6567 Followers
Summary:
- Intel’s disastrous string of earnings suggests deep, fundamental problems.
- The company’s strategy and leadership appears to be increasingly out of touch with reality, deepening our concerns.
- Accountability and intervention is needed to truly turn the company around.
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Intel’s (NASDAQ:INTC) disappointing fourth quarter 2022 earnings received significant media attention, however, we believe the full extent of the company’s problems may have been overlooked. In our opinion, many investors view the challenges facing Intel as a buying opportunity, assuming that the business will eventually recover and return to higher levels. However, we believe that the company’s strategy and competitive position are fundamentally broken and may lead to further declines in share prices and a significant restructuring. In addition, we are concerned about the growing disconnection between management and reality, and believe that accountability and intervention are necessary to revive the company.
In this article, we will outline our concerns, as well as provide a comprehensive analysis of the company’s financials and valuation, to aid investors in making an informed decision regarding the stock.
Q4 Takeaways
In the fourth quarter of the year, Intel reported sales revenue of $14.0 billion, falling short of the expected consensus of $14.5 billion by 3.1%. The company’s gross profit margin was 43.8%, which was 120 basis points lower than its guidance, and its operating profit margin of 4.3% missed the consensus estimate by 240 basis points. Earnings per share of $0.10 were 11 cents lower than the consensus estimate.
We note that gross margins have not been this low since 1986.
For the first quarter of 2023, Intel provided sales guidance of $11 billion at the midpoint, which is 21.3% lower than the expected consensus of $14.0 billion. The non-GAAP earnings per share guidance of -$0.15 is 42 cents below the consensus estimate.
Reviewing our notes, we are reminded of bull’s defense of Intel after they posted disastrous Q3 results, with the main line of argument suggesting that the company has already kitchen sinked numbers and guidance. Now that the company reported Q4, we still see the same line of arguments reappearing in support of Intel. We believe it is very rare for a large company like Intel to post two consecutive quarters of shockingly bad earnings, and experience tells us that when this happens, investors would be prudent to be double down on caution rather than greed.
A common error among investors when dealing with fundamentally flawed companies and stocks is to put excessive focus on the minutia and management’s commentary. This can cause investors to lose sight of the bigger picture and become overly fixated on small details. We will avoid this mistake by looking at the company’s structural challenges instead.
The Strategy: Everywhere, Everything, All at Once
On January, 2021, Intel hired Pat Gelsinger as CEO to lead the company’s turnaround. Gelsinger took over the next month and soon after announced an ambitious plan to turn the company around.
To refresh memories, the announced plans on March 2023 were to aggressively reclaim technology leadership in chip design and manufacturing, while becoming a major chip manufacturer for other firms, similar to rivals Taiwan Semiconductor (TSM) and Samsung (OTCPK:SSNLF). The plan which include the construction two chip manufacturing plants in Arizona at a cost of $20 billion and additional plants in the U.S. and Europe in the coming year. In essence, the plan reminds me of the title of recently released blockbuster film, “Everywhere, Everything, All at Once”.
Increasing Concern
Our concerns about the plans in question were significant at the time due to the discrepancy between the goals, the company’s execution capabilities, and Mr. Gelsinger’s track record. Despite our doubts, we approached the situation with a positive and receptive attitude, perhaps due to a feeling of patriotism as an American. However, this subject matter is more fitting for a relaxed Friday night discussion over several drinks.
We grew increasingly concerned as the gap between the company’s measurable results and Mr. Gelsinger’s increasingly optimistic rhetoric. In early 2022, we were shocked by his plan to introduce five nodes in four years, and his end-of-decade moon shot goal of taking the US from 12% to 30% of global manufacturing, and taking Europe from 9% to 20%. We are too polite to question anyone’s sanity in this public forum, but it is Mr. Gelsinger himself who asked, “a bunch of you looked and said, have you gone nuts?” We will, once again, reserve our opinions on this matter for discussion over several strong drinks.
AMD
In June 2022, Mr. Gelsinger stated that the challenge of AMD taking share is “in the rearview mirror”. However, in the company’s latest earnings call, Mr. Gelsinger acknowledged, “We lost share. We lost momentum.” While nobody has a perfect track record of making predictions, we find bombastic comments when addressing serious market loss concerns to be reflective of a deeper issue of management being out of touch with reality.
AMD (AMD), on the other hand, continues to be confident in its ability to gain share over the long term. During its November 2022 earnings call, AMD CEO Lisa Su stated, “Longer-term basis, I think the product portfolio and the product capabilities should help us continue to gain share.”
The equilibrium of credibility has undergone a pronounced alteration in favor of AMD, following the recent earnings call by Intel. This occurrence carries profound fundamental ramifications, including their aptitude to secure the most exceptional human capital, the consumer’s notion of originality, and the shareholder’s propensity to reciprocate with confidence in bullish predictions.
Financials and Valuation
Intel’s EPS reached its highest point in 2021 at $5.47 per share, driven by the growing demand for PCs and cloud workloads. However, the company ended 2022 with $1.84 per share. For 2023, if no additional downward revisions are made, which is a huge uncertainty, Intel is estimated to earn $0.60 per share. Given Intel’s unpredictable business performance, it’s difficult to trust any consensus projections at this stage.
Our primary concern is Intel’s rapid decline in cash flow and capital expenditures. In order to support CEO Gelsinger’s ambitious multi-pronged strategy against competitors AMD, NVIDIA (NVDA), TSMC, and Samsung, the company incurred approximately $25 billion in capital expenditures in 2022, compared to $14 billion in 2020, prior to Gelsinger’s appointment. Meanwhile, operating cash flow decreased from $35 billion to $15 billion, leading to a significant drop in free cash flow from a positive $21 billion to a negative $9 billion.
Without a reversal of its ambitious strategy, which may require the departure of CEO Gelsinger and cause additional uncertainty in our opinion, the company could be constrained by elevated capital expenditures in the near future. Although consensus projections should be approached with caution, given our belief that they remain optimistic, they predict Intel’s net debt to rise to $37.5 billion by 2025, an increase from $12.5 billion in 2020.
Conclusion
Our aspirations for the triumph of Intel are unwavering. Nevertheless, in our opinion, the divergence between management’s rhetoric and the company’s actual outcomes has become so marked that it is our civic responsibility to highlight the incongruity. To re-establish consumer and investor confidence, Intel may need to address the core concerns of insufficient competitiveness, production difficulties, and declining financial well-being in a credible manner. Given Intel’s ineffective strategy and persistently missed forecasts, we will adopt a prudent stance and observe from the sidelines.
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.
Additional disclosure: This article is for educational purposes only and does not constitute financial or investment advice. Please do your own due diligence and consider your unique financial needs and constraints before buying any stock.