After rough start to the year, Intel Corporation (NASDAQ:INTC) shares have finally got their groove back. Currently sitting just slightly below multi-year highs, and INTC stock now shows a not-too-shabby 22.7% YTD gain. In any other year, a 20%-plus gain would be considered spectacular. But right now it appears pretty pedestrian.
INTC stock has been dead money for the past couple of years, and right now it appears to be mostly benefiting from an irresistible sympathy rally. To a large extent, INTC stock is piggybacking on a red-hot tech sector, particularly in the chip and memory industries. The Technology Select Sector SPDR Fund (NYSEARCA:XLK) has rallied 33.4% YTD while iShares S&P NA Tec. Semi. Idx. Fd.(ETF) (NASDAQ:SOXX) is sitting on a splendid 46.6% gain.
Sure, Intel was impressive during the third quarter, but mainly after cost-cutting measures delivered a much-needed boost to the bottom line. And, the PC market has flatlined again after a brief resurgence.
At 13.9 times forward earnings, INTC looks cheap. In contrast, other leading chip names are trading at considerably richer valuations. For instance, contract chip manufacturer Taiwan Semiconductor Mfg. Co. Ltd. (ADR) (NYSE:TSM), one of Intel’s fiercest competitors, now trades at 18.6 times earnings while Texas Instruments Incorporated (NASDAQ:TXN) trades at 21.8 times earnings. Meanwhile, NVIDIA Corporation (NASDAQ:NVDA), another GPU/CPU rival, commands a rich price-to-earnings (PE) multiple of 42.7.
INTC stock largely sat out the tech party, which is one big reason why the shares look so cheap. But, there can be some advantage to being cheap in a market where trying to find value is like the proverbial needle in a haystack. Studies have shown that in a market downturn, low PE stocks tend to fare better than higher ones. A relatively cheap stock like INTC can therefore offer better downside protection for investors than its more-expensive peers.
However, the sad truth though is that Intel is cheap for a reason: investors just don’t expect to see a ton of growth coming from the company. To put things into perspective, analysts expect Intel’s sales growth to fizzle out to just 2.8% in 2018 from 4.3% in the current year. Meanwhile, the company’s earnings per share growth is expected to drop to an anemic 3.8% in 2018 after expanding an impressive 36.3% in 2017. The outlook is expected to improve only slightly in 2019 with revenue expanding 3.5% while EPS grows 6.4%.
In short, things are likely to go south from here for Intel.
That certainly figures to be a daunting proposition for long-term INTC stock shareholders. There’s a method to the madness though, and Intel is hardly to blame. A booming year in the memory market has had the bulls ringing the register. Intel’s fledgling memory business, Non-Volatile Memory Solutions Group, expanded at a 37% clip to $891 million during the last quarter, making it the company’s fastest-growing segment. Intel has in recent years doubled down on its memory business, going as far as converting one of its logic factories into a NAND factory. Further, the company has collaborated with Micron Technology, Inc. (NASDAQ:MU) to create 3D XPoint, a first-of-its-kind non-volatile memory chip that’s 10x faster than NAND and considerably cheaper than DRAM.
Too bad the analysts are now saying to brace for hard times ahead. The memory party is about to turn to a real snooze fest — if a cross-section of numerical navel gazers are to be believed. Gartner and Morgan Stanley have predicted a looming cyclical downturn in the NAND and DRAM markets starting as early as the fourth quarter. The wider semiconductor market is expected to grow 2.7% in 2018 and just 0.2% in 2019, a far cry from 12.3% in the current year.
Meanwhile, Intel’s pivotal Data Center Group (DCG) seems to be stuck in single-digit growth mode after growing in double-digits in recent times. DCG is, of course, highly strategic to the company because its sheer size helps to offset the continued decline in the Client Computing Group. During the last quarter, DCG recorded growth of 7% to $4.9 billion, the slowest among non-PC segments.
At first glance, this appears quite disconcerting, however, the slip is more by design than by accident. Intel is moving away from mainly selling server processors to enterprises which build their private data centers to selling the chips to megacloud providers such as Amazon.com, Inc. (NASDAQ:AMZN) and Alphabet Inc (NASDAQ:GOOGL). Intel started shipping Skylake Xeon chips to cloud providers about a year ago. That’s a smart move because the secular trend is for organizations moving their workloads from private to public clouds. Indeed, Intel said that its DCG revenue by cloud service providers surged 35% during the quarter while that by enterprise and government fell 11%. Cloud-related revenue now accounts for 60% of DCG revenue.
To be sure, it’s only a matter of time (maybe a year or less) before DCG returns to double-digit growth.
The near-to mid-term outlook for INTC stock doesn’t look very attractive. Even in the absence of a memory market downturn, INTC will still have to grapple with a flat PC market as well as a data center segment that’s still a work in progress. Luckily, the company is likely to bounce back maybe four-to-six quarters down the line. Still being cheap, INTC stock looks like a good Hold for the long haul.
As of this writing, Brian Wu did not hold a position in any of the aforementioned securities.