Computer processor maker Intel (NASDAQ:INTC) fell short of analyst expectations in Q2 FY2022 quarter, with revenue down 21.9% year on year to $15.3 billion. Guidance for the next quarter also missed analyst expectations with revenues guided to $15.5 billion at the midpoint, or 16.9% below analyst estimates. Intel made a GAAP loss of $454 million, down on its profit of $5.06 billion, in the same quarter last year.
Intel (INTC) Q2 FY2022 Highlights:
- Revenue: $15.3 billion vs analyst estimates of $17.9 billion (14.5% miss)
- EPS (non-GAAP): $0.29 vs analyst estimates of $0.70 ($0.41 miss)
- Revenue guidance for Q3 2022 is $15.5 billion at the midpoint, below analyst estimates of $18.6 billion
- The company dropped revenue guidance for the full year, from $76 billion to $66.5 billion at the midpoint, a 12.5% decrease
- Free cash flow was negative $6.38 billion, down from positive free cash flow of $5.54 billion in previous quarter
- Inventory Days Outstanding: 114, down from 119 previous quarter
- Gross Margin (GAAP): 36.4%, down from 57% 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.
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 growth over the last three years has been unimpressive, averaging 1.94% annually. Last year the quarterly revenue declined from $19.6 billion to $15.3 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).
This was a difficult quarter for Intel, with revenue decreasing by 22% year on year, missing analyst estimates by 14.6%.
Intel's revenue growth has slowed for the last three quarters and the company expects growth to turn negative next quarter guiding to a 19.3% year on year decline, but before the results Wall St analysts were expecting revenues to grow 3.2% over the next twelve months.
Product Demand & Outstanding Inventory
Days Inventory Outstanding (DIO) are an important metric for chipmakers, as it reflects the capital intensity of the business 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 inventory days came in at 114, 13 days above the five year average, suggesting that despite the recent decrease the inventory levels are still higher than what we used to see in the past.
Intel's gross profit margin, how much the company gets to keep after paying the costs of manufacturing its products, came in at 36.4% in Q2, down 20.6 percentage points year on year.
Despite declining over the past year, Intel still retains reasonably high gross margins, averaging 49.1%, pointing to a still solid competitive offering, good cost controls, and a lack of significant pricing pressure.
Intel reported an operating margin of 9.24% in Q2, down 20.6 percentage points year on year. Operating margins are one of the best measures of profitability, telling us how much the company gets to keep after paying the costs of manufacturing the product, selling and marketing it and most importantly, keeping products relevant through research and development spending.
Operating margins have been trending down over the last year, averaging 21%. However, Intel's margins are still above average for semiconductor companies, driven by an efficient cost structure.
Earnings, Cash & Competitive Moat
Analysts covering the company are expecting earnings per share to grow 26.2% over the next twelve months, although estimates are likely to change post earnings.
Earnings are important, but we believe cash is king as you cannot pay bills with accounting profits. Intel's free cash flow came in at -$6.39 billion in Q2, down 224% year on year.
Intel produced free cash flow of $5.06 billion in the last year, which is 6.89% of revenue. It's good to see positive free cash flow, since that allows it to strengthen its balance street, but we wouldn't want to see its free cash flow yield drop much lower.
Intel’s average return on invested capital (ROIC) over the last 5 years of 21.1% implies it has a strong competitive position and is able to invest in profitable growth over the long term.
Key Takeaways from Intel's Q2 Results
Sporting a market capitalization of $164 billion, more than $27 billion in cash and with positive free cash flow over the last twelve months, we're confident that Intel has the resources it needs to pursue a high growth business strategy.
A highlight was Intel’s improvement of their inventory levels this quarter. That feature of these results really stood out as a positive. On the other hand, it was unfortunate to see that Intel's revenue guidance for the full year missed analyst's expectations. Overall, it seems to us that this was a complicated quarter for Intel. The company currently trades at $28.4 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 while its high return on invested capital suggests it is well run and in a strong position for profit growth, unfortunately cash burn raises the question of whether it can sustainably maintain its growth.
Intel's price to earnings ratio based on the next twelve months is 11.8x. While we have no doubt one can find things to like about the company, and the price is not completely unreasonable, we think that at the moment there might be better opportunities in the market.
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