Intel Q3 2020 – Under siege.

The foundation shakes

• Intel followed IBM in reporting weakness in the cloud which was more than offset by the PC market, but this was not enough to calm the market which fears a weakening of Intel’s foundations as well as a resurgent AMD.
• Intel Q3 revenues / EPS were $18.3bn / $1.02 broadly in line with consensus at $18.3bn / $1.00 and raised guidance for the full year to $75.3bn / $4.90.
• The market is spooked because Intel sold fewer high margin data centre chips and more low-margin PC chips and because the data centre is Intel’s crown jewel which now may be having difficulty.
• During the pandemic, the cloud has been driven by two factors.
  • First, the need to ensure business continuity and upgrade systems to allow employees working from home to be effective.
  • Second, the need to cut costs and conserve cash in an uncertain economic environment.
  • This has caused medium-sized and smaller companies to only spend on the cloud where they have to which has resulted in weakness in some areas of the cloud as IBM has observed for the last two three quarters.
• This what Intel saw in its Data Center Group in Q3 2020 as government and businesses now have their contingency plans in place and are looking to save money.
• These customers saw a decline of 47% YoY in the data centre which was partially offset by growth from the cloud providers themselves (AWS etc) and from telecom operators.
• The net result was a 7% decline in data centre revenues and a 17-point decline in EBIT margin to 32%.
• It is this that has spooked the market because if Intel is going to continue to struggle with its profitability, then the rating that is attributed to the shares by the market will also fall.
• This is why the shares fell so hard on Friday, giving up all the gains that they have made since Q2 2020 when it announced further problems with its 7nm manufacturing process.
• Furthermore, the decision to sell its memory business to SK Hynix for $9bn has given the market the impression that Intel intends to retrench rather than innovate.
• This is fine when one utterly dominates a market and there is no competition in sight, but with Intel, this is simply not the case.
• On one side Intel is facing a resurgent AMD which is producing products that appear to be better than Intel’s and on the other, the usage of Arm-based processors in the data centre remains an increasing probability.
• Retrenching into this environment is a dangerous game and perhaps what Intel needs to do is to aggressively take the fight back to the insurgents by making better products.
• There is not much sign of this and as a result, the outlook is that the stock could continue to retrench further as the market devalues its earnings.
• Rising earnings and a falling share price is a recipe for deep value and Intel is approaching this territory.
• At $48.2 the shares are on 9.8x 2020 PER with a dividend yield of 2.7%.
• If the shares drift to $44, I am going to have a strong inclination to hold my nose and buy the shares as they will be on a 2020 PER of 9.0x and a dividend yield of 3%.
• I don’t think Intel is going to cut the dividend because it can afford to pay it and because it has been aggressively defending the share price with a large share buyback all year.
• In an environment of 0% interest rates for an indefinite period, Intel starts to look very attractive.