Intel Growth Returns

Intel (INTC) technology risks have declined as its markets are returning to growth. Semiconductor manufacturers’ volatility causes them to trade at a discount despite their growth. Intel products are propriety, not commodities. Intel is the dominant firm in a completive Capital goods market. It is worth more than the 12.7 P/E ratios when the S&P is at a P/E of 22.5. It is a strong buy.

Profitability

The table below demonstrates that revenue was $1.2 billion above guidance and the highest in history, although only by a fraction of a percent. Gross Margin was down by 5.6 percentage points because of 10nm yields, which reduced operating income by 12% from the prior year. Net income was down 6% but the share buyback lowered the EPS by 2%. Analysists were impressed by the revenue growth and not supersized by the lower gross margin.

Source: Intel

Impact of

New Products

Lower yields on the 10 nanometer (nm) chips reduced third-quarter operating income by a billion dollars. Bob Swan, Intel’s CEO, spoke about the above projection improvement in yields. Still, the higher 10 nm volume will reduce fourth-quarter gross margins by another 2 percentage points. Improved yields are projected to be the main driver increasing gross margins next year. Gross margins in 2020 are expected to be 60%, up 2% from 2019.

Management set the date for 7nm introduction in the third quarter of 2021. The production of the 7nm will move from Litho to EUV (Extreme Ultra Violet). They emphasized that the speculations for the 7nm are much simpler than for the 10nm. That chip is 2.7 more components than the 14nm while the 7nm has 2 times the density of the 10 nm. Intel will bring out more new chips utilizing the 10nm process in 2020. This will include data center chips.

The 5nm chip, which has more than 10 times the density of the 14 nm chips, will be introduced two to two and a half years after the 7nm. Intel plans to return to process cycles of that time frame.

Market

Management sees the signs of recovery in the data center market (DCG). The Cloud grows rapidly followed by periods of digestion before picking up again. Intel has introduced a new chip with built-in Artificial Intelligence (AI). Mobileye (Car Controls) and NSG‘s fast retrieval memory are growing fast but they will not be 10 % of sales until next year.

Intel is still short of capacity for low-end PCs. In 2020, they will expand production capacity by 25%. To meet the demand for low-end chips, they will add 14nm capacity as well as 10nm and 7nm capacity. They anticipate that low-end chip sales will increase in the mid-single digits in 2020. Eighteen PCs have been designed with the 10nm chip. Half are on the market. The chips are in the higher end of the market. More chips will enter the PC market next year.

The following table illustrates the sales by segment in the third quarter.

Revenue by Business Unit Q3 2019 vs. Q3 2018

PC-centric CCG $9.7 billion down 5%

DCG $6.4 billion up 4%

Internet of Things IOTG $1.0 billion up 9%

Mobileye $229 million up 20%

NSG $1.3 billion up 19%

PSG $507 million up 2%

Total Data-centric 9.5billion Up 6%

Source: Intel

Earnings Projection

The following table illustrates the likely scenario for 2020. A 6% growth, which is slightly higher than the third quarter’s 5.5% growth, yields revenue of $75 billion. With management’s expectation for improved Cloud and PC sales, this is on the conservative side. Management guidance for gross margin is 60%. This is a 2-percentage point improvement. This scenario assumes a $10 billion buyback of 177 million shares as part of the $20 billion buybacks.

The 2020 earnings of $5.70 are 29% above the 2019 GAAP earnings. The stock should increase with increased earnings. However, the 60% gross margin is management’s guidance for the full year. The gross margin in the fourth quarter is expected at 57% and the first quarter will probably be lower than 60%. It is also possible that the depressed P/E rate will move toward the S&P P/E rate.

Conclusions

A return to growth is likely to happen as the new products appear in volume and the Cloud begins to grow again. Intel is a strong buy.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any 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.