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Morningstar | Another Record Quarter for Wide-Moat Intel Renews our Confidence in Shares of the Chip Titan

Amid a backdrop of a potential cyclical downturn in semiconductors, supply shortfalls, and competitive concerns from AMD’s aggressive product roadmap, Intel turned in record third-quarter results while raising its full-year guidance for the third consecutive quarter. Revenue for 2018 is expected to be $71.2 billion versus the firm’s forecast of $65 billion at the beginning of the year, thanks to broad-based strength in core PC and data center markets, as well as traction from Mobileye’s EyeQ ADAS chips, Altera’s server FPGAs, memory, and modems for Apple’s iPhone. Despite persisting negative market sentiment for shares of this wide-moat chip titan attributed to its ongoing CEO search, well-publicized 10-nanometer delay, and AMD’s increased competitiveness, we reiterate our positive thesis on Intel.

We are maintaining our $65 fair value estimate for the firm and believe prospective investors should find current levels enticing, as we expect Intel to successfully defend its turf across both PC and server CPU arenas, while continuing to generate substantial traction in Artificial Intelligence and automotive via its auxiliary business units.

Third-quarter revenue rose an astounding 19% year over year and 13% sequentially, to $19.16 billion. Client computing group, or CCG, sales rose 16% year-over-year to $10.2 billion thanks to strength in 2-in-1 and gaming PCs as well as modem share gains in the iPhone. Reported supply shortages notwithstanding, the firm enjoyed 6% PC CPU volume growth while notebook and desktop ASPs rose 4% and 10%, respectively, as Intel prioritized Core processors in its manufacturing network. Similarly, data center group, or DCG, sales increased 26% year over year to $6.1 billion with volumes and ASPs up 15% and 10%, respectively thanks to prioritization of Xeon scalable processors.

Cloud-based DCG sales grew 50% during the quarter, accelerating from a 41% clip last quarter. We estimate cloud and communication service provider-related DCG sales account for about two thirds of total DCG revenue. While these torrid growth rates in cloud spending won’t remain at such lofty levels, we think Intel should comfortably tally at least a 10% growth rate for DCG over the next few years.

The firm also executed well in its other data-centric segments, including Internet of Things, nonvolatile memory, or NSG, and programmable solutions (Altera) groups, or PSG. Notably, NSG sales rose 21% thanks to solid SSD and Optane traction in the data center, while over half of the firm’s data center and client SSD volume is on the 64-layer 3D NAND process, which bodes well for profitability. The firm achieved positive operating income in the segment for the first time this year with margins of about 15%. Meanwhile, Micron recently announced its intention to buy out Intel’s share of the duo’s flash joint venture for $1.5 billion, which includes the fabrication facility in Lehi, Utah that makes 3D XPoint memory. We note the deal is expected to close in the next 6 to 12 months and Intel will continue to receive supply for up to a year afterward. Interim CEO Bob Swan noted the firm expects to have reliable supply through 2020.

Meanwhile, PSG sales grew 6%, led by data center FPGA growth that was up 45%. In comparison, we note Xilinx recorded data center sales for the quarter that rose 28%, implying superior traction for Intel-Altera with its Programmable Acceleration Card with an Intel Stratix 10 FPGA. Mobileye revenue grew 50% thanks to ongoing strength in ADAS adoption. The Israel-based automotive subsidiary of Intel also recorded 8 new design wins and shipped 3.3 million EyeQ system on chips during the quarter, bringing the lifetime total to 33 million. We continue to be very positive on the Intel-Mobileye combination as future product lineups incorporate more sophisticated capabilities for semi-autonomous functions. Intel’s cost-control efforts should also be applauded, in our view, as the gross and operating margins rose to 64.5% and 38.4%, respectively, despite growth in dilutive products such as modems and memory. Worth noting is the firm’s operating expense as a percentage of revenue were at the lowest levels in over a decade at 26%.

Management projects fourth-quarter sales to be $19 billion, implying full-year revenue of $71.2 billion and full-year top-line growth of 13%, which would mark the first double-digit growth year since 2011. For the year, data-centric sales are estimated to be up 20% while PC-centric revenue will grow 9% year-over-year. We believe both of these levels are attainable, though the firm’s supply constraints will limit further upside, in our view, as Intel will prioritize Xeon and high-value Core processors in lieu of Internet of Things and entry-level PC products. Swan foresees capital expenditures reaching $15.5 billion for the year as the firm balances 14-nm capacity increases, 10-nm capacity ramp, and memory investments. For 2019, Swan noted capital expenditure will be tilted toward logic (10-nm) with memory spending being lower, consistent with our overall outlook for wafer fabrication equipment suppliers.

One of the critical factors in our outlook on the fortunes of both Intel and AMD is the misconception of AMD’s product roadmap. AMD will be sampling server CPUs for the rest of the year and likely won’t ramp production of these chips until sometime in 2019. PC chips will follow the ramp of AMD’s data center GPU and CPUs at TSMC. Consequently, we don’t believe AMD’s process node advantage (we believe Intel's 10-nanometer is more or less equal to TSMC's 7-nm in terms of transistor density) will be nearly as long as current market levels imply, especially with Intel expected to ramp its PC chips throughout 2019 in time for the holiday season, with server chips thereafter. We note the qualification process for server processors is fairly length, implying share shifts for server CPUs will be much more gradual relative to PC CPUs, which is positive for Intel competitively.

For more insight into our thoughts on Intel's efforts in the data center and AMD's competitiveness, please see our recent report, "Concerns Over the Demise of Intel's Data Center Leadership Are Overdone."