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Morningstar | Intel Delivers a Monster 2Q Led by the Data Center Group; Raising FVE to $65. See Updated Analyst Note from 27 Jul 2018

In the wake of the departure of its CEO, Intel delivered fantastic second-quarter results thanks to an impressive showing by the data center group, or DCG, while raising its full-year top-line guidance by $2 billion. Amid a PC market in secular decline and a semiconductor market fraught with competition, Intel is on track to record its first year of double-digit revenue growth since 2011. We applaud the firm's efforts to transform from a PC-centric behemoth into a data-centric chip titan with a broad product portfolio for data processing, storage, and transfer. Shares were down 5% during after-hours trading, as we postulate the market extended its enthusiasm for AMD's recent positive earnings performance by discounting Intel. Meanwhile, we surmise Intel's delayed 10-nanometer product ramp (with pertinent systems not reaching shelves until the second half of 2019) also contributed to the after-hours weakness. Nevertheless, between the firm's short-term financial outperformance and long-term scattershot approach to address challenges in connectivity (5G), computing (artificial intelligence, or AI, and cloud), and memory (3D NAND and 3D XPoint), we remain positive on wide-moat Intel's prospects. We are raising our fair value estimate to $65 per share from $62 per share as we incorporate the updated 2018 guidance. With the recent sell-off, we think Intel offers a compelling investment opportunity.

Second-quarter revenue was $17 billion, up 15% year over year as all major business units grew. Notably, client computing group sales grew 6% to $8.7 billion, as recent macroeconomic strength has spurred CIOs to refresh aging PC fleets at the enterprise level. Furthermore, the ongoing renaissance in PC gaming has also spurred average selling prices, with desktop ASPs up 13% over the same period last year. DCG revenue rose an astounding 27% over the prior year as the firm's latest Xeon scalable platform meets explosive demand from hyperscale cloud vendors (up 41% year over year), particularly for data-intensive workloads in AI. Intel's latest Xeon CPUs accounted for nearly 50% of its server product mix, bolstering year-to-date DCG ASPs by 9% and driving year-over-year DCG operating margin expansion from 38% to 49%.

Management expects second-quarter sales to be at a midpoint of $18.1 billion, which would imply 12% year-over-year growth. We concede AMD has had some noteworthy traction with certain new products in the PC and server space with CPUs and GPUs to compete against Intel and Nvidia, respectively. However, these offerings remain in the early stages of roll-out, and we don't foresee Intel or Nvidia's moat being encroached, particularly at the high-end of valuable markets such as PC gaming, AI accelerators, and cloud computing.

Intel's delay in 10-nm will require it to keep innovating on its 14-nm process. Worth noting is that Intel has improved the performance of its 14-nm chips by 70% from the first iteration of 14-nm products launched in 2014 to present day offerings, so we're not overly concerned about the delayed transition to 10-nm. To maintain its robust gross margins (61.4% during the quarter), Intel must perfect its process technology to yield roughly 85% to 90% good product per wafer. Overall, Intel is balancing the timing and profitability of its latest process node transition with the competitive environment. Based on its recent and forecast financial performance, we believe the firm's balancing act has been successful thus far.

We remain intrigued in Intel's opportunity to compete against Nvidia in the AI and autonomous driving arenas. We are skeptical of Nvidia's market-appointed leadership position in the two markets and think Intel can leverage its recent acquisitions to prosper in a post-PC world. Its string of acquisitions (Altera, Mobileye, Nervana, Movidius, and recently eASIC) all offer solutions for the spectrum of AI challenges.

For more information on Intel's opportunity in autonomous driving, please see our April Technology Observer, “Automotive Chipmakers in the Fast Lane – Destination: High-Speed Growth.”