Computer processor maker Intel (NASDAQ:INTC) reported Q2 FY2023 results exceeding Wall Street analysts' expectations, with revenue down 15.5% year on year to $12.9 billion. The company also expects next quarter's revenue to be around $13.4 billion, slightly above Consensus estimates. Intel made a GAAP profit of $1.48 billion, improving from its loss of $454 million in the same quarter last year.
Intel (INTC) Q2 FY2023 Highlights:
- Revenue: $12.9 billion vs analyst estimates of $12.1 billion (6.69% beat)
- EPS (non-GAAP): $0.13 vs analyst estimates of -$0.03 ($0.16 beat)
- Revenue guidance for Q3 2023 is $13.4 billion at the midpoint, above analyst estimates of $13.3 billion
- Free cash flow was -$2.73 billion compared to -$8.76 billion in the previous quarter
- Inventory Days Outstanding: 131, down from 153 in the previous quarter
- Gross Margin (GAAP): 35.8%, down from 36.5% in the same quarter last year
Inventor of the x86 processor that powered decades of technological innovation in PCs, data centers, and numerous other markets, Intel (NASDAQ: INTC) is the leading manufacturer of computer processors and graphics chips.
Founded in 1970 by Gordon Moore, Robert Noyce, and Andy Grove, Intel’s first business was actually focused on building memory chips,dynamic random-access memory (DRAM). The company had a near monopoly in the late 1970s, before Japanese competitors crushed Intel on pricing, prompting one the great pivots in tech history when it switched its focus to computer processors and was selected by IBM to provide the processor for the first PC in 1981. Intel’s x86 processor architecture subsequently became the industry standard for PCs, transforming the company into the dominant provider of chips used in PCs and data centers for decades.
Once revered for both its R&D and manufacturing prowess, Intel failed to diversify into growing end markets such as smartphones, 4G/LTE, and GPUs because it didn’t want to get into these (at the time) smaller and less profitable end markets - especially when it had a near monopoly in the highly profitable CPU business.
Over the past decade, Intel’s manufacturing edge first stagnated, and today trails rivals TSMC and Samsung, reducing its pricing power and margins. Intel faces ongoing challenges as its former x86 strongholds in PCs and datacenters are threatened by GPUs and ARM-based alternatives.Intel's primary competitors are Advanced Micro Devices (NASDAQ:AMD) and Nvidia (NASDAQ:NVDA), and Qualcomm (NASDAQ:QCOM).
Processors and Graphics Chips
Chips need to keep getting smaller in order to advance on Moore’s law, and that is proving increasingly more complicated and expensive to achieve with time. That has caused most digital chip makers to become “fabless” designers, rather than manufacturers, instead relying on contracted foundries like TSMC to manufacture their designs. This has benefitted the digital chip makers’ free cash flow margins, as exiting the manufacturing business has removed large cash expenses from their business models.
Intel's revenue has been declining over the last three years, dropping by 11% on average per year. This quarter, its revenue declined from $15.3 billion in the same quarter last year to $12.9 billion. Semiconductors are a cyclical industry, and long-term investors should be prepared for periods of high growth followed by periods of revenue contractions (which can sometimes offer opportune times to buy).
Even though Intel surpassed analysts' revenue estimates, this was a slow quarter for the company as its revenue dropped 15.5% year on year. This could mean that the current downcycle is deepening.
Intel may be headed for an upturn. Although the company is guiding for a year-on-year revenue decline of 12.6% next quarter, analysts are expecting revenue to grow 3.17% over the next 12 months.
Product Demand & Outstanding Inventory
Days Inventory Outstanding (DIO) is an important metric for chipmakers, as it reflects a business' capital intensity and the cyclical nature of semiconductor supply and demand. In a tight supply environment, inventories tend to be stable, allowing chipmakers to exert pricing power. Steadily increasing DIO can be a warning sign that demand is weak, and if inventories continue to rise, the company may have to downsize production.
This quarter, Intel's DIO came in at 131, which is 23 days above its five-year average. These numbers suggest that despite the recent decrease, the company's inventory levels are higher than what we've seen in the past.
In the semiconductor industry, a company's gross profit margin is a critical metric to track because it sheds light on its pricing power, complexity of products, and ability to procure raw materials, equipment, and labor. Intel's gross profit margin, which shows how much money the company gets to keep after paying key materials, input, and manufacturing costs, came in at 35.8% in Q2, down 0.6 percentage points year on year.
Intel's gross margins have been trending down over the last 12 months, averaging 38%. This weakness isn't great as Intel's margins are already far below other semiconductor companies and suggest shrinking pricing power and loose cost controls.
Intel reported an operating margin of 3.52% in Q2, down 5.7 percentage points year on year. Operating margins are one of the best measures of profitability because they tell us how much money a company takes home after manufacturing its products, marketing and selling them, and, importantly, keeping them relevant through research and development.
Intel's operating margins have been trending down over the last year, averaging 4.02%. This is a bad sign for Intel, whose margins are already among the lowest for semiconductors. The company will have to improve its relatively inefficient operating model.
Earnings, Cash & Competitive Moat
Wall Street expects earnings per share to decline 257% over the next 12 months, although estimates will likely change after earnings.
Although earnings are important, we believe cash is king because you can't use accounting profits to pay the bills. Intel's free cash flow came in at -$2.73 billion in Q2, down 57.3% year on year.
As you can see above, Intel failed to produce positive free cash flow over the last 12 months and shareholders will likely want to see an improvement in the coming quarters.
Over the last five years, Intel has reported an average return on invested capital (ROIC) of just 14.2%. This suggests it struggled to find compelling reinvestment opportunities within the business.
Key Takeaways from Intel's Q2 Results
Although Intel, which has a market capitalization of $143 billion, has been burning cash over the last 12 months, its more than $24.3 billion in cash on hand gives it the flexibility to continue prioritizing growth over profitability.
In May 2023 at a conference, Intel management remarked that the company's Q2'23 revenue would come in at the high end of guidance. Instead, it exceeded the high end, which is a big positive for a company where there are questions about revenue stability. Additionally, next quarter's revenue and EPS guidance both slightly exceeded Consensus expectations. Lastly, we liked seeing Intel's improvement in inventory levels. On the other hand, its deteriorating operating margin isn't a great sign. Overall, this quarter's results were positive amid low expectations and shareholders should feel optimistic. The stock is up 6.1% after reporting and currently trades at $36.68 per share.
Is Now The Time?
When considering Intel, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. We cheer for everyone who is making the lives of others easier through technology, but in the case of Intel we will be cheering from the sidelines. Its revenue growth has been very weak, and analysts expect growth rates to deteriorate from there. And on top of that, unfortunately its operating margins reveal subpar cost controls compared to other semiconductor businesses, and growth is coming at a cost of significant cash burn.
Intel's price to earnings ratio based on the next twelve months is 29.9x. While we have no doubt one can find things to like about the company, we think there might be better opportunities in the market and at the moment don't see many reasons to get involved.
The Wall St analysts covering the company had a one year price target of $32.7 per share right before these results, implying that they didn't see much short-term potential in the Intel.
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