Intel: Turnaround Is Working, I’m Bullish
Contributor since 2023 / 1887 Followers
Summary:
- Intel’s stock has dropped almost 40% YTD due to slow traction in AI compute sales and declining share in the data center market.
- Despite what initially appears to be disappointing Q1 results, Intel is showing signs of a turnaround with revenue growth in key areas and strategic investments.
- Intel’s upcoming launch of the 18A Panther Lake CPUs and strong partnerships position the company for future growth and market leadership.
- In essence, the turnaround appears to be working under the surface; I am bullish.
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Investment Thesis
While I have been bullish on Intel (NASDAQ:INTC) since last fall, I will admit, the company has faced a tumultuous start to 2024 with their stock performance plummeting approximately 40% from January to the present.
Intel’s faltering stock price is largely attributed to their slow traction in the realm of artificial intelligence compute sales relative to competitors such as Nvidia (NVDA) and AMD (AMD) where the company has lost ground in the AI and server segments. Intel, in recent history, has struggled to pivot their business model and product line in the past years that has resulted in a declining share in the data center market since 2021, which was once a stronghold for the company. With the company introducing the Gaudi 3 AI chip, the company has a new angle on the AI market, but this will take time to ramp up.
While financial performance in Q1 2024 indicates that although Intel reported a 9% increase in revenue, their profit forecasts and market guidance were disappointing. The company’s guidance for Q2 2024 projects flat revenue growth and a significant reduction in profits compared to the previous year.
To help with this, Intel is planning to invest $100 billion in expanding their manufacturing capabilities across the United States. However, the immediate impact of these investments is still uncertain, and the market remains skeptical of Intel’s ability to execute these plans swiftly and effectively.
In essence, the stock is down 39.29% YTD, but I think the turnaround is taking hold. The company’s last earnings report and recent reporting have made it sound like they are not getting traction. I think this is far from the truth post Q1. The company is showing the beginnings of a turnaround (in my opinion). I think the market will soon catch up.
The recent surge in AI demand, spurred by developments in machine learning and data analytics, has also led Intel to forge partnerships with other tech companies. Intel will manufacture chips specifically for AI applications for Microsoft (MSFT), which is expected to help the company capture a substantial share of the AI market.
For these reasons, I believe that the stock continues to be a strong buy.
Why I Am Doing Follow-Up Coverage
Unfortunately, since my previous analysis, Intel’s stock has dropped by 30.98%, severely underperforming the S&P 500’s rise of 3.15%. I believe much of this decline is due to the market’s reaction to the company’s Q1 2024 earnings report, which left investors doubtful about the strength of the company’s turnaround. Adding to investors’ concerns, the Chinese government’s ban on the use of Intel technology in government computers has created additional downside pressure on the stock. On the surface, there is a lot to be bearish about.
The point of this piece, however, is to show that when we break this down section by section, the company is actually starting to execute. This is a far more bullish view than what current stock price behavior is indicating about the stock.
Breaking Down Results: Only Foundry Is Shrinking
Despite beating earnings per share expectations (EPS of $0.18 beats by $0.04/share) and revenue of $12.72 billion only missed slightly $56 million, Intel provided a weaker than expected forecast for the current quarter that led to a drop in their stock price. Critics state that Intel needs visionary leadership to reclaim their lead in the semiconductor industry.
However, the company is actually pursuing a strong recovery in key areas that will power the company going forward. For example, the company’s Client Computing Group (CCG) posted revenue that jumped 31% year over year. This is largely PC chips sales (which I believe have not fully priced in AI PC sales, which I think are a big catalyst).
Their data center division grew 5% year over year as well. While this may seem low, keep in mind that new AI chips like the Gaudi 3 are just starting to be shipped to customers. I am optimistic that we can see revenue here accelerate.
The dark spot is what was their IFS (Intel Foundry Services) division, which saw revenue drop 10% to $4.4 billion in Q1. I’ll mention this in the commentary below, but I actually think there is a silver lining here too.
Management Commentary Points To A Foundry Resurgence
To review, the biggest drag on revenue growth is the foundry division, with revenue declining 10% year over year. However, this is exactly the place I think management is starting to provide qualitative commentary to show the path is changing. Starting on the Q1 call:
The foundry market is expected to grow from $110 billion today to $240 billion by 2030 with almost 90% of the growth coming from EUV nodes and advanced packaging. Given this backdrop, we have clear line-of-sight to becoming the largest system foundry for the AI era and the second-largest overall by 2030, building on our EUV High NA process technology, leadership in advanced packaging, manufacturing capacity, our systems expertise and the surge in AI demand.
Put it another way, our 15 billion of external revenue embedded in our Intel Foundry target model would represent less than 15% of the leading-edge foundry market. It is not a question of if, but when Intel Foundry achieves escape velocity. And every day, we are proving to the market that Intel Foundry is a resilient, sustainable and trusted alternative to serve a semi-market on a path to top 1 trillion by the end of the decade.
-Q1 Call
With this, I continue to be optimistic about the company, especially with their upcoming launch of the 18A Panther Lake CPUs in mid-2025 -which is part of their “five nodes in four years” plan. This presents prospects for the company to regain their market leadership with a new line of CPUs designed to enhance AI computing performance.
More recently, during this month’s BofA Global Technology Conference, John Pitzer, Intel’s Corporate Vice President, expressed strong optimism about the 18A process technology (part of the fabrication foundry services). He described the 18A as an essential component of Intel’s future product line-up:
…we have an opportunity to capitalize on [our ARM opportunity] with Intel Foundry, both on the advanced packaging side and on the wafer side. And I would be remiss not to remind people about a year ago, we actually made a joint announcement with ARM on R&D announcement, a multi-year co-development announcement, we were going to optimize their latest cores on Intel 18A. -Pitzer, Global Technology Conference
I think announcements like this are key. CEO Patrick Gelsinger is very confident in the technology and has made it clear that the success of the 18A CPUs is critical to their future. He’s even been quoted saying that he has “bet the whole company on 18A” to better compete in the semiconductor industry. This process technology is expected to improve AI applications compared to predecessors through the Panther Lake CPUs, which will deliver up to twice the AI capabilities of the earlier Arrow Lake chips. The 18A CPUs are set to follow shortly after the 20A chips’ rollout.
But I think the bet has been smart. In another event, VP Pitzer proudly mentioned:
We now have 6 Intel 18A external foundry customers. We’ve got a lifetime deal value of greater than $15 billion. And I think we’re well on our way to our aspirations of being the second largest external foundry by 2030. -Pitzer, Goldman Sachs Global Semiconductor Conference
Their deal with Microsoft, worth up to $15 billion, involves Microsoft designing their semiconductor chips and utilizing Intel’s foundry services for manufacturing. The deal is a huge win for Intel as it penetrates the “Magnificent Seven” to drive significant volumes through the company’s foundry business.
To sum this all up, here’s why this matters: Intel’s story does not yet seem like a successful turnaround according to some analysts. However, breaking each section of the business down, one by one, we either see the beginnings of revenue growth (Data centers and in Client Computing Group), or strong qualitative data from the foundry group (through management commentary) to show that they are executing well here too. The company now appears to be in a much better position than what initially was assumed after their Q1 report.
Valuation
Most of Intel’s forward growth metrics appear to trail the sector median. For example, their revenue (according to Seeking Alpha) is projected to decline by 2.09% over the next 12 months (while the sector median will grow revenue by 3.32%). Given this, why do I think the company has upside?
I think we have to look deeper at what the potential here is. Intel’s revenue in some divisions is growing well while Foundry is dragging the average down. Foundry’s revenue is affected by two levers of growth:
One, external orders like Microsoft.
Two, internal orders by the CCG and server divisions.
In my opinion, both of these are set to ramp up inside (CCG sales are already up 31% year over year; many of these orders will flow down to Foundry). Given this, I believe growth estimates are likely too pessimistic.
This takes me to the company’s Price to Earnings Growth (PEG) ratio, which shows where I think the upside is. With a forward P/E ratio of 28.00 compared to the sector median of 24.17, Intel’s valuation is roughly 15.83% higher than the industry average.
However, by a PEG ratio metric, the company is severely undervalued, and I think this is where we need to focus.
The company’s forward PEG ratio is 0.58 which is a 71.31% discount to the sector median of 2.02. This is a huge discount and basically tells me the market is underestimating Intel’s estimates for growth.
I think this is where the upside lies on Intel. While I don’t think (for now) the company can match the sector’s PEG ratio of 2.02, I think they do deserve to trade at a PEG ratio of 1 (which would normally indicate the market is fairly valuing the company’s growth prospects).
If we could see the company’s PEG ratio grow from 0.58 to 1, this would represent a 72.41% upside in the share price. This would equate to a fair value around $52.51/share.
Where This Fits In With My Previous Valuation
Previously, I argued that Intel shares were worth around $82.19/share after analyzing the company from multiple price to book and price to sales figures and converging on a blended upside.
What has happened since then is that guidance has been weaker than expected, so I wanted to value Intel on the PEG ratio since this means we can build a valuation off a compound metric that considers both where the company’s forward P/E is today and what the market thinks are their growth estimates. Unfortunately, this means my short-term price target is lower now ($52.51/share), but I do still believe in the long run shares can reach the $82.19 figure as the company starts to see growth accelerate.
Risks
For a few years, Intel has been slower to adapt to new computing trends compared to their peers. For instance, the delay in adopting EUV lithography impacted their ability to compete in semiconductor manufacturing, allowing rivals like TSMC (TSM) to surge ahead. Their technological lag is the top of a list of lost strategic opportunities, including missing the initial boom in mobile chips, which was a critical turning point for the semiconductor industry (and while they had early deals with Apple to provide some of their chips, these deals later faltered).
Intel’s server market share has also been threatened by aggressive competitors like Nvidia and AMD. Nvidia is leveraging their advancements in AI and memory technologies, while AMD has gained a significant foothold in the server market, which was previously dominated by Intel.
The next leg, however, in computing, I still believe is one Intel can win. The industry is in dire need of energy-efficient AI chips that even China has decided to explore. Leading accelerators are now reaching power draws that are orders of magnitude higher than just a few years ago, which is raising alarms not just among chipmakers but also data center operators and regulators worldwide. In response, Intel offers products with lower energy footprint for similar inferencing capabilities. For instance, their Hala Point (which is used for research purposes so far) is claimed to be the world’s largest neuro-morphic system to enable sustainable AI, and uses Intel’s Loihi 2 processor that consumes “100 times less energy at speeds as much as 50 times faster than conventional CPU and GPU architectures.”
What I am saying here is that the company missed quite a few core computing trends of the last two decades, and it would be easy for analysts to assume (based on headline numbers) that Intel is missing the AI computing game as well. This is far from the truth (as we have seen diving deep into each section of their business). AI computing represents one of the single biggest competitive changes that have to adapt to, but also one of their biggest opportunities.
Bottom Line
While Intel has clearly faced challenges and market skepticism, the company is already taking measures to revitalize their business that I believe are starting to bear fruit and that the market is missing. With this, Intel still represents a unique investment opportunity, in my opinion. The stock may have dropped, but the company’s fundamentals, combined with in-demand products due to their energy efficiency and a strong government-backed financial support, provide a strong foundation for future growth and recovery.
The company has truly gone through a rocky start to 2024, with their stock price falling roughly 39% amid challenges in adapting to AI trends and maintaining their stronghold in the data center market. Despite launching the Gaudi 3 AI chip, Intel has struggled to recover market confidence swiftly. But I think this will change in the coming months. The company will regain their competitiveness, particularly with the forthcoming 18A Panther Lake CPUs, which are valuable to Intel’s strategy to enhance AI computing capabilities.
The stock’s current valuation through analyzing the PEG ratio presents a compelling case for the stock being a strong buy. I continue to be bullish.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of AMD, INTC either through stock ownership, options, or other derivatives. 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.
Noah Cox (account author) is the managing partner of Noah’s Arc Capital Management. His views in this article are not necessarily reflective of the firms. Nothing contained in this note is intended as investment advice. It is solely for informational purposes. Invest at your own risk.
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