Justin Sullivan
Intel’s stock (NASDAQ:INTC) plummeted to a 52-week low on Monday (August 22) as market concerns over continued Fed hawkishness return. The stock held intraday declines of more than 4%, underperforming the broader semiconductor index (-3.7%), as well as key benchmarks S&P 500 (-2.1%) and Nasdaq 100 (-2.7%). The recent flurry of Fed official support for another jumbo rate hike coming in September, to rein in 40-year high inflation, even if it comes at the price of an economic recession, has added pressure to Intel’s stock performance by heightening fears of a cyclical decline that already has the company reeling from a PC slump.
The continuation of the stock’s declines – which also missed out on last week’s relief rally on expectations for a potential Fed pivot in 2023 as inflationary pressures seems to have eased – underscores that there is still much left to do for Intel to regain investor confidence after consistently succumbing to execution snags on its comeback plan under CEO Pat Gelsinger’s leadership over the past several quarters. Even the latest upbeat news on Brookfield Asset Management’s (BAM) recent investment into Intel’s foundry efforts has done little to lift the stock from its current slump. In addition to broad-based macro headwinds weighing on Intel’s operational capabilities, Gelsinger has also acknowledged the company’s “execution issues in areas like product design, DCAI, and the ramp of AXG offerings” for its larger-than-expected fundamental mishap.
While Intel has promised reacceleration in 2H22, the company’s year-end results are expected to underperform in the near-term as ongoing efforts to right its ship are becoming increasingly complex with added macro uncertainties, which is consistent with management’s decision to downwardly adjust guidance on both the top- and bottom-line. The following analysis will provide a walkthrough on key considerations across Intel’s core business segments to gauge their implications on the stock’s near-term prospects.
Although our long-term outlook on the stock remains optimistic considering anticipated share gains and peer profit-sharing through Intel’s return to its foundry roots, as well as continued ramp-up on key new products to accelerate penetration into secular data center and auto opportunities, there will likely be further turmoil in the share price performance in the near-term given elevated execution risks on its strategic turnaround.
Client Computing Group (“CCG”)
CCG currently houses Intel’s primary PC sales, which has the most significant exposure to consumer end-markets. The segment currently accounts for more than 50% of Intel’s consolidated sales mix, and boasts one of the highest operating profit margins across the broader business thanks to scaled productivity over the past decade. But despite still being the market leader in core PC processors, Intel is gradually losing market share to competition while also dealing with address from broad-based market slowdown due to weakening consumer sentiment ahead of rising recession risks.
Earlier investor concerns of a slowing semiconductor cycle after a two-year pandemic-driven boom are now turning into reality, with chipmakers collectively sounding the alarms on slowing demand from consumer end markets. Accelerated declines in global PC shipments observed in the first half of the year are pointing to an estimated 9.5% market contraction for calendar 2022.
This is consistent with Intel’s expectations for a 10% reduction in the related total addressable market (“TAM”) due to “macro weakness, characterized by broadening consumer weakness”. The dour outlook is further corroborated by Intel’s observations of underperforming PC shipment volumes in the second quarter to its largest customers who are now quickly tapering inventory levels to brace for the anticipated decline in consumer PC demand (estimated 13.1% drop in 2022), as well as deceleration in enterprise PC demand (estimated 7.2% drop in 2022) despite the segment’s relative resilience against near-term macro headwinds.
While peers like AMD (AMD) are looking to offset some of the near-term consumer PC weakness with still-resilient enterprise demand, Intel’s launch of the new “Raptor Lake” 13th-generation Intel Core PC processors in the fall might be “too little too late”. Not only did the upgrade cycle miss out on the past two years’ surge in pandemic-driven demand, the upcoming Raptor Lake roll-out also coincides directly with the thick of a market slowdown.
Despite Intel’s hopes of riding on strong upgrade cycle tailwinds, buoyed by an estimated base of more than 600 million obsolete PCs that feature technologies that are four years and older, the delayed roll-out of Rapid Lake risks further market share loss to rivals, highlighting its poor internal execution skills. The failed “catch up game” is expected to have a hard hit on Intel’s bottom-line performance over coming months given the CCG segment’s substantial contribution to its consolidated sales and margin mix. This is consistent with the company’s negative free cash flow guidance for the year, which inadvertently points to a grim valuation outlook in the near-term.
Data Center and AI Group (“DCAI”)
Robust secular demand for data center processors has been a lifeline for the semiconductor industry amid a looming cyclical downturn. The need for data center technologies is expected stay elevated in coming years, as cloud-computing becomes an increasingly critical factor for enabling operational and economic efficiency within the corporate sector. As a result, demand for data center processors is expected to expand this year by at least 20%, which significantly contrasts the slowdown in consumer-centric segments due to macroeconomic weakness.
And over the longer-term, investments into cloud adoption by the enterprise sector is expected to reach more than $800 billion by mid-decade. This will accordingly lift demand for supporting AI hardware such as data center chips, with the related TAM expected to expand at a CAGR of 43% towards $1.7 trillion by 2030.
While these statistics continue to support a resilient demand environment for both hyperscalers and chipmakers against near-term macro uncertainties, Intel ironically stands to lose out further on related secular tailwinds:
Turning to DCAI, as we stated at Investor Day, over the next couple of years as we rebuild our server product portfolio, we expect to grow slower than the overall data center market. It’s not a fact we like, but the forecast we see. We have a singular focus to regain performance and TCO leadership across all workloads and use cases from enterprise to cloud.
This, again, highlights Intel’s untimely execution of its strategic comeback plan. Key rival AMD continues to disrupt Intel’s market leadership in data center server processors with next-generation offerings catered to a wide range of use cases spanning cloud-computing, communications infrastructure, and telco deployments. The fabless chipmaker is also on track to debuting its 5th Gen “Turin” EPYC server processor in 2024, which caters to general and cloud-optimized applications. Built on the 4nm and 3nm manufacturing processes, AMD’s Turin EPYC processors are expected to unlock some of the best-in-class performance capabilities. Meanwhile, Intel has delayed the roll-out of its competing offering, the next-generation “Sapphire Rapids” Xeon server processors, which risks further market share loss to up-and-coming contenders like AMD:
The DCAI point, as I said in my formal comments, we were disappointed. Some of that was driven by the macro…But as we also said, we had some of our own unique execution issues and we kept the quality bar high on Sapphire Rapids and thus we did another stepping, which was a forecast, which put some inventory and reserve issues in front of us as opposed to high ASP new product revenue.
Source: Intel 2Q22 Earnings Call Transcript
However, it is worth highlighting that Intel has, nonetheless, continued to make positive inroads with establishing long-term working partnerships with key hyperscalers including Meta Platforms (META) and AWS (AMZN) in recent quarters, paving the road for sustained demand to support the segment’s long-term growth. Intel’s recent acquisition of Granulate, an “Israel-based developer of real-time continuous optimization software”, also enables the provision of end-to-end solutions over the longer-term. Not only does the provision of software drive higher margin sales, it is also expected to facilitate greater cross-selling opportunities on complementary hardware, supporting further ramp-up of new data center product deployments, as well as improving market share gains over the longer-term.
Outside of Intel’s foray in AI and data center opportunities, the company continues to make favourable progress in the provision of programmable solutions through continued ramp of its “flagship Agilex FPGA” processors. As mentioned in our previous coverage, field programmable gate arrays (“FPGA”) are “programmable circuits that can accommodate the fast-changing nature of modern-day technology requirements”:
A single FGPA can potentially consolidate discrete components because of its versatile nature. Specifically, the circuits could be programmed and configured to facilitate a certain function and be reprogrammed whenever changes are required. FGPAs are widely used in emerging technologies like cloud data center and communications infrastructure applications considering its adaptive nature and ability in enabling low-latency AI acceleration. The global FPGA market is forecasted to grow at a CAGR of 8.5% over the next five years, as rising adoption of emerging technologies continues to bolster demand.
Source: “Where Will Intel Stock Be In 5 Years?” and “AMD: What You Need To Know About The Planned Xilinx Merger“
This accordingly puts Intel in a unique position to capture accelerating demand across the global 5G enterprise market, where related opportunities are expected to expand rapidly at a five-year CAGR of 28.5% towards $10 billion, a favourable tailwind to partially offset the near-term execution mishap on data center server processor prospects.
Network and Edge Group (“NEX”)
In addition to FPGAs, NEX is one of the few areas where Intel is making positive progress. The segment’s revenues topped $2.3 billion (+11% y/y; +1% q/q) in the second quarter, a new record buoyed by robust 5G and Ethernet demand, which is consistent with market observations outlined in the earlier section. And this momentum is expected to carry through 2023, as new products like “Mount Evans”, Intel’s latest infrastructure processing unit (“IPU”) co-developed with Google (GOOG / GOOGL), enter start of production, with pent-up demand coming from notable hyperscalers. While Intel is falling short on expectations when it comes to capitalizing on data center server processor demand ahead of accelerated cloud-computing demand, its NEX offerings – similar to FPGAs – are expected to be a positive offset.
As an IPU that is made with a hyperscaler for hyperscalers – what’s not to love about Mount Evans? The Mount Evans IPU is essentially a data processing unit (“DPU”) that enables “movement, processing, security and management” of workloads across data centers. Featuring a “multi-host adapter functionality [that connects] up to four Intel Xeon CPUs”, the Mount Evans IPU makes a competitive offering against even the most powerful DPUs currently available in the market, such as Marvell’s (MRVL) LiquidIO server adaptors and OCTEON DPUs. Similar to Marvell’s infrastructure processor offerings, Intel’s Mount Evans IPU is also accompanied by comprehensive software development kits (“SDKs”), including the “Infrastructure Programmer Development Kit” (“IPDK”), to enable seamless and scalable end-to-end solutions to customers.
Accelerated Computing Systems and Graphics Group (“AXG”)
The AXG segment primarily consists of sales pertaining to GPUs deployed across a wide-range of use cases spanning PCs, data centers, and high-performance computing (“HPCs”) / supercomputers. The AXG segment also houses development of blockchain accelerators, as well as other custom accelerators to capitalize on demands from nascent technologies.
Similar to both macro headwinds and execution shortfalls observed in CCG, AXG is “not expected to hit [its] GPU unit target” this year. The segment’s bottom-line is also being squeezed by increasing costs of deployment and ramp-up on its product roadmap, in addition to rising risks of inventory build-up.
Specifically, the ramp-up of Intel ARC “Alchemist” gaming GPUs are being thwarted by the global slowdown in PC shipments and subsequent tapering of OEM inventory levels ahead of the cyclical downturn. The delayed roll-out of next-generation Intel Arc A5 and A7 desktop graphics cards that are being deployed later in the current quarter also coincides with a period marked by accelerated declines in GPU demand observed across the broader peer group, adding another punch to the segment’s underperformance.
Meanwhile, Intel’s market leadership in HPC is also being overshadowed by rapid market share erosion by rival AMD once again. The “AMD Instinct MI200” series data center GPU processors powered by AMD’s latest CDNA 2 architecture can now be found “across the world’s 10 largest hyperscalers and plays a critical role in powering some of the most powerful supercomputers in the world”, putting industry leader Intel on notice. The hope is that Intel’s counteroffering, the newest “Arctic Sound-M” data center GPUs which entered production and customer delivery this year, can help it regain footing. As a “multi-purpose GPU for data center workloads” addressing a wide range of use cases spanning “media streaming and gaming, [to] AI visual interference and virtual desktops”, the Arctic Sound-M cards stand to capitalize on burgeoning demand from nascent technology trends.
Intel Foundry Services (“IFS”)
One of the biggest challenges that Gelsinger has taken up after becoming CEO at Intel is the introduction of “IDM 2.0”, which aims to return the company to its foundry roots and take advantage of the benefits that come with vertical integration in chip manufacturing. Under IDM 2.0, Intel seeks to partner with “third-party foundries and to include manufacturing for a range of modular tiles on advanced process technologies, including products at the core of Intel’s computing offerings for both client and data center segments beginning in 2023”. This includes the long-anticipated “Meteor Lake” CPUs, the successor of the Raptor Lake CPUs discussed in the earlier section, which is expected to leverage Intel’s 7nm process and industry partner TSMC’s (TSM) 5nm process with deployment beginning 2023.
In addition to cost and innovation benefits stemming from the continued ramp-up of IFS under IDM 2.0, we also view the strategy as a prudent way to engage in profit-sharing across its fabless chip contenders such as AMD and Nvidia:
The strategic expansion comes at an opportune time as global digitization across every industry continues to accelerate at an unprecedented pace, which has driven a widening divergence between demand and supply for semiconductors. Foundry is expected to grow into a $100 billion market over the next five years, and much of this projected growth will be driven by demand for new computing technologies such as AI, cloud, 5G and edge computing.
Source: “Where Will Intel Stock Be In 5 Years?“
The CHIPS Act, which was recently signed into law by President Biden, also bodes favourably with Intel’s new strategy. Under the CHIPS Act, Intel seeks to benefit from $52 billion in government support aimed at furthering the build-out of U.S. chip production to regain “chip supremacy” lost to Asian markets – specifically China – in recent years.
However, consistent with IFS’ nominal contribution to Intel’s consolidated sales mix, related efforts are still years out from ramping up to scale and making meaningful impact to the company’s near-term underperformance. While we remain optimistic on IDM 2.0 in helping Intel regain market share and engage in profit-sharing from rivals, related efforts are still a long way from fruition, underscoring elevated execution risks ahead.
Mobileye
Mobileye has really been the consistent star of the show for Intel. The chipmaker’s early decision to acquire Mobileye was a prescient move that gave it a first-mover advantage on partaking in accelerating global adoption of advanced driving assistance systems (“ADAS”) and autonomous driving technologies, which are fast-approaching an inflection point:
The global market for autonomous driving technology is expected to grow at a CAGR of 14% up to 28.5% over the next five years, making strong tailwinds for Mobileye. The majority of this growth will be led by the robotaxi sector, which is expected to grow rapidly at a CAGR of 60.7% up to 120.5% through to 2025.
Source: “Where Will Intel Stock Be In 5 Years?“
And the subsidiary has yet to disappoint, boasting operating margins that are consistently greater than 40%, alongside continued growth. Mobileye has already expanded its autonomous vehicle testing program from its home base in Israel to some of the busiest and most complex driving environments in the world, including New York City, Detroit, Paris, Munich and Shanghai.
Despite the subsidiary’s favourable fundamental progress, the segment’s contribution to Intel’s consolidated performance remains nominal. Instead, the core focus is now on Intel’s upcoming plans for Mobileye’s IPO later this year, which is expected to unlock new value for shareholders. With the TAM for auto chips expected to exceed $100 billion by 2030, Mobileye is well-positioned to capitalize on high-growth opportunities that warrant a higher valuation on a standalone basis over the longer-term as the deployment of its technologies ramp-up.
Final Thoughts
Based on the foregoing analysis, Intel still has a lot of work on its plate before the anticipated optimism on its long-term prospects can be realized. Specifically, CCG, DCAI, and AGX shortfalls will take a while to recover given added pressure from near-term macro headwinds, which slows the respective segments’ ramp trajectory. The biggest downside risk is that these three segments also account for the bulk of Intel’s fundamental performance, foreshadowing continued pressure on its near-term valuation prospects. Meanwhile, segments that are well capitalizing on current market opportunities including NEX, IFS and Mobileye, remain in early stages of growth that will still take some time to ramp-up before making any meaningful contribution to the company’s bottom-line.
For now, Intel still has a lot of work left to do to restore its credibility and investors’ confidence in the company’s ability to hold on to its market leadership. While we believe sustained long-term growth remains on the table for Intel, we caution further volatility ahead on the stock in the near-term as further underperformance in the underlying business awaits.
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