Intel (INTC) had one of the most disastrous quarters ever witnessed in a couple years, sending the stock down nearly 8% in pre-market trading. The reason shareholders were terrified? Everything that could go wrong did go wrong this quarter, and it wasn’t like shareholders were anticipating a phenomenal quarter, but just a less than horrendous one, which was the exact opposite of what had occurred.
Intel reported revenue of $16.1 billion versus consensus expectation of $16.02 billion representing a $90 million beat. We anticipated that Intel would deliver a revenue beat on Q1’19 results via the earnings preview article we published yesterday. Heading into the quarter, we thought Intel would at least produce $16.2 billion in revenue on the basis of declining PC Client revenue, and growth in Data-Centric revenue. But, the degree to which Intel was pricing dependent in Client Computing was alarming, partially owed to the fact that Intel’s CPU-mix shifted towards higher-end variants, and a drop-off in low-end volumes tied to Chromebooks and low-end desktop PCs. Hence, pricing moved significantly higher.
Intel’s volumes fell by -7% in Notebooks and fell -8% in desktop computing. Global PC shipments declined -4% in Q1’19, hence the added negative impact was tied to loss of market share to AMD (appx. 3% loss of volume shipments to Advanced Micro Devices (AMD) in desktops and 4% loss of volume shipments in Notebooks y/y). What helped offset this impact was a +13% improvement in average selling prices in the Notebook segment and +7% improvement in average selling price in the Desktop segment off-setting volume with higher-pricing. However, this dynamic likely won’t continue, as pricing is a function of performance per dollar, and as AMD continues to deliver better performance per dollar, the resulting outcome is obvious, Intel won’t be able to boost pricing to offset volume losses.
Keep in mind, PC shipment volumes in Q1’19 will translate more negatively into Q2’19, as inventory will have to clear the channel next quarter when they report results, which translates to Intel’s poor performance on volumes were tied Q4’18 PC shipment volumes, as opposed to Q1’19, so when you thought things couldn’t get worse, they’re just about to.
Even more alarming was the fact that Intel reported -5% revenue in the Data-Centric segment (which has been a growth category for quite a while). What happened? Well, analysts anticipated that the Data-Centric segment would be the last pillar to fall in Intel’s arsenal, but instead the data-centric segment saw challenges in virtually all business units. The drop-off in unit volumes were -8% y/y whereas average selling prices improved +1% y/y. The problem with this? Intel shareholders haven’t experience a decline in the data-centric business in an extremely long time (we might have to go back to the Athlon 64 era from 2005 to 2006) to reference a case where Intel reported struggling results in the datacenter market.
Intel reported dil. EPS of $0.89 versus consensus estimates of $0.87 dil. EPS, so while the earnings results did beat by a narrow margin the narrative on profitability is expected to worsen. Gross margin fell 4% in Q1’19, which was driven by the 10nm node ramp (late and also more expensive), as wafer yield are always lower during the first year of production. On-going concerns tied to other areas of the business, i.e. NAND/Optane Memory (NSG) -12% y/y, FPGAs -2% (PSG) also added more downside. While the memory/NAND business could recover, it’s also dependent on a lot of factors beyond its control (such as a cut in production from Samsung and SK Hynix along with a stronger demand environment for mobile/PC shipments).
Because of these weakening metrics across the entire data-centric unit (which is also the highest-margin area of the business), the profitability narrative had worsened to a point where Intel’s outlook fell below the consensus estimate range for Q2’19. Intel offered financial outlook of $15.6 billion revenue for Q2’19, and $0.89 dil. EPS for Q2’19. This compared to consensus estimates of $16.85 billion and $1.01 for Q2’19 ($1.25 billion miss on revenue outlook and $0.12 dil. EPS miss, respectively).
Nomura Instinet analyst David Wong took on a more contrarian stance following the earnings report, while maintaining his Buy rating and $65 price target:
Intel’s June-quarter sales and EPS guidance were below consensus and our estimates, and the company lowered its full-year 2019 sales and EPS guidance. While the semiconductor downturn is clearly continuing to affect Intel (and other chip companies), we remain positive on the stock, given the= company’s solid profitability and its leadership in what we think will be some of the most promising semiconductor end markets (e.g., artificial intelligence, autonomous driving, and data center), which we think will drive growth for Intel when the broader business environment improves. We are maintaining our Buy rating on the stock.
At this point, the only thing that could be constructive from this quarterly earnings report, is the fact that it gives Intel more aircover to restructure its business. To provide a spark, Intel may need to consolidate more of its business units, such as selling off its Dalian fab facilities (memory/NAND production), broader workforce reduction (10-15% reduction in global headcount), inventory charge-offs, and the announcement of an accelerated share repurchase program. Furthermore, Intel’s 14nm facilities should be depreciated more aggressively (given the transition to 10nm), and because of the 14nm fab to 7nm transition at its Chandler, AZ facility as well. The useful life of 14nm far-exceeded expectations, but with everything already going wrong, Intel might as well record accelerated depreciation tied to the 14nm fab once 10nm hits the market in Q3’19.
The top-line is unlikely to improve near-term, so taking the opportunity to re-orient the business towards better efficiency (rather than over-expansion into areas not tied to its core business) would provide a near-term relief valve, for shareholders. However, revenue and operating margin inflection could take a number of years. So, if you’re committed to this journey – stay on board but expecting a near-term turnaround would be wishful thinking at this point.
Disclosure: The author has no positions in Intel or AMD stock.