Intel: Relentless Carnage Demands Damage Control
Contributor since 2012 / 41822 Followers
Summary:
- Intel Corporation’s Q2 earnings report was disastrous, and there was a bleak Q3 forecast.
- Gross margin headwinds and higher non-core business charges hurt Intel, despite efforts to reduce spending and improve profitability.
- Intel is exploring strategic options, including a potential spin-off of its foundry business and significant spending cuts, to boost shareholder value.
- Despite some positive developments, Intel remains in damage control mode, with better chip stock alternatives available for investors.
- Lost your shirt here? Let us help you get back to even.
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Intel Corporation (NASDAQ:INTC) stock continues to suffer. A few months ago there was hope that they had figured things out, and that a more domestic chip company would do better in this macro/geopolitical climate versus those wrapped up in potential trade wars. The recently reported Q2 earnings report released a few weeks ago, however, was a disaster. That threw cold water all over the long thesis.
In fact, it was a double-line miss, and a down guide for Q3 below estimates. The company also is completely suspending the dividend starting in the fourth quarter after cutting it several quarters ago. The simple fact is that Intel missed results relative to many of our expectations. We were anticipating seeing some recovery in PCs. We saw progress on Foundry. While the top and bottom-line miss is painful, the guide was a disaster. Now it seems the company and management are scrambling to stabilize the business. There are recent developments which impact our sell rating from the mid-$20s. Let us discuss.
Before delving into the various recent developments, which are significant by the way, we wanted to point out that the biggest weaknesses we saw were in gross margin headwinds and higher charges in non-core businesses in Q2. But it is messy here, folks! The company has been implementing spending reductions and is taking steps to improve profits and strengthen the balance sheet. The goal is to improve cash flow and reduce the debt balance while enabling the company to make strategic investments to drive long-term value for shareholders.
But there is no sugar-coating it. It deserves to be stated that the Q2 financial performance was disappointing. Some positives are there, such as Intel accelerating its IDM 2.0 transformation. There is also the pending launch of Intel 18A next year to help the company regain strength in the market and improve profitability.
However, the near-term margin headwinds, high expenses and charges, despite spending reductions, have not been enough. The icing on the cake here was suspending the dividend in Q4 to help shore up the balance sheet and reduce debt. Something had to be done. Comps for Q2 2023 showed across-the-board pain. Intel’s revenue was down 1% from a year ago, and below expectations. This came as adjusted gross margins missed badly versus our expectations at 38.7%, down from 39% a year ago, and well below historical averages.
Operating margins were awful, just 0.2%, down 330 basis points. EPS was a paltry $0.02, down from $0.13. Finally, the last thing we want to say about Q2 since we discussed it enough was that Client Computing was strong, with revenue rising 9% to $7.4 billion, but slightly off what many were expecting. Data Center and AI managed to be down 3% to $3.0 billion, while most chip companies are seeing strong data center-related growth. Network and edge were down 1% as well. Foundry was of little concern, seeing $4.3 billion in revenue and up 4%. Altera revenue was down 57%, while Mobileye also sank 3%. Not a good quarter. Where do we go from here?
A spin-off in the cards?
We saw very recently ahead of Labor Day, that the company is, in fact, exploring strategic options to boost shareholder value. One of the segments that is working well, though still below expectations, is its foundry business. Well, according to a Bloomberg report, it seems Intel is now weighing splitting its foundry business out, via a spin-off. Further, it is considering scrapping factory projects. Both Morgan Stanley (MS) and The Goldman Sachs Group, Inc. (GS) are providing advice on potential options strategically.
It is too early to tell what will happen here because discussions are still in the early stages. It is very likely the best ideas will be presented during a board meeting in September. The company will likely also continue to delay expansion efforts as it shores up the balance sheet.
More spending cuts
We also learned yesterday that there are more cuts on the table. CEO Patrick Gelsinger and some other key executives are allegedly set to cancel or alter its plans later in the month to the board to cut unnecessary businesses and restrict even more capital spending. According to this latest report, the plan is anticipated “to include ideas as to how to trim overall costs by selling businesses,” which could consist of its programmable chip unit Altera.
Clearly, CEO Patrick Gelsinger is trying to keep his job. We could see more movement on the Board, too. One possible cut in this proposal may also include plans to pause or completely shelve its $32 billion factory in Germany. This remains to be seen.
Settling out R2 litigation
There was another good piece of news for Intel. In a release late Friday, we saw that Intel has agreed to resolve all legal disputes with R2 Semiconductor. For those who may not recall, this stems from a lawsuit brought about two years ago. R2 is a smaller technology group in California that has been in a patent battle with Intel and many big Intel customers for nearly two years. Such costs of litigation are unclear, but settling is almost always the cheaper route. While the settlement amount is unclear as yet, it is safe to assume it is a small fraction of the overall possible damages.
“The parties are pleased to have resolved the dispute on mutually agreed-upon terms.”
The duo’s legal dispute dates back to November 2022 when R2 filed patent infringement lawsuits against Intel and some major customers like Dell and Amazon and specifically involved Ice Lake, Tiger Lake, and Alder Lake processors, its 10th, 11th, and 12th generation processors. The reason customers were included is that those businesses were selling laptops containing those processors. This is another good piece of news.
Partnering with Japan
Now, all we are hearing about is the major plans to cut spending. But one new expense has arisen just today. Apparently, the Japanese national research institute is now partnering with Intel to build a research and development center in Japan. If it pans out, this new center in Japan will be built by 2027-2029. Primarily, it will focus on extreme ultraviolet lithography equipment.
What is interesting about this announcement is the timing. It comes just days after the reports of major capital spending cuts, which include possibly shelving the Germany plant as mentioned above and taking other measures to cut the spending, such as cutting the dividend completely. Japan’s National Institute of Advanced Industrial Science and Technology will run the facility, while Intel will provide strategic expertise. This also comes as the company is cutting jobs, but will be an expense of several hundred million dollars.
Looking ahead
So, we have seen some developments here, and more developments with the Board could come after the September meeting. Independent of all of these moves, combined with expenses, the company guided to a Q3 loss of $0.03 adjusted. Perhaps this will be not as bad if spending around some of the aforementioned items is reduced. Still, the guide is really painful. To get the balance sheet improved, yes, the company will save $0.5 billion a quarter by suspending the dividend, and could save a lot by tabling the German plant. Job cuts will reduce operating expenses. Total R&D and marketing, and general and administrative expenses to approximately $20 billion in 2024 and approximately $17.5 billion in 2025, with further reductions expected in 2026. Perhaps the latest moves will accelerate this expense reduction. But the reality is that 15% of employees are being let go by the end of this year, and the company is fighting for market position.
Take home
While Intel Corporation is in damage control mode, we still believe there are far superior chip stocks to own. While there may be a long-term turnaround in the cards, there is a lot of forest ahead before the company is out of the woods.
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.
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