Give credit where credit is due. I’ve had more than my share of worries about Intel (NASDAQ:INTC) this year, but thanks to a third-quarter earnings report last month that impressed investors, Intel stock has rallied nicely.
And the gains are deserved. From a fundamental perspective, Intel’s Q3 was impressive. Headline numbers crushed analyst consensus estimates. Full-year adjusted earnings per share guidance was raised by 20 cents.
Commentary after the report also drives some confidence. On the Q3 conference call, management reiterated its projection that 7nm production would arrive in 2021. After years of delays at 10nm, that outlook inspires hope that Intel’s development processes are back on track.
That said, the current rally to $58 seems to incorporate most, if not all, of that optimism. Broader worries still hold, and looking closer Q3 earnings weren’t quite as good as the headline beat and guidance raise suggest.
INTC stock isn’t necessarily a short here, and it remains cheap enough that value investors might see an opportunity. But the concerns that have dogged Intel stock aren’t completely dispelled by a single quarter, and I still believe chip bulls have better options elsewhere.
A Closer Look at Q3 Earnings
Again, from a headline perspective, Intel’s Q3 looks like a classic, and usually bullish, beat-and-raise quarter. And the numbers did impress.
That said, Intel received a bit of outside help. A lower-than-expected tax rate, based on quarterly guidance given after Q2, appears to have contributed about 3.5 cents to earnings. The same is true relative to the full-year outlook: a one-point reduction in the estimated tax rate added roughly 4.5 cents to the full-year EPS outlook.
Of course, Intel beat Q3 guidance by 18 cents and raised its full-year guidance by 20 cents. Tax rates play only a modest role on both fronts, but it’s worth noting that the implied outlook for the fourth quarter isn’t much higher than it was after Q2.
It’s been hiked just two pennies or less than 2%. That increase appears to have come mostly, if not solely, from a lower tax rate and a lower share count thanks to buybacks.
As a result, at least per guidance, the third-quarter results aren’t necessarily the sign of a sudden acceleration in growth. That sense is confirmed by looking at the results themselves and ignoring expectations. Updated full-year guidance still suggests the adjusted EPS will increase by just two cents. Non-GAAP operating income should decline by about 6% year-over-year.
Q3 was better than expected, certainly. But looking at fourth quarter and full-year guidance, it doesn’t suggest that Intel has proven its on a path to growth.
Helpful Commentary on Development
That said, the commentary on the third-quarter conference call does offer some support for the mid-term outlook. Intel seems on track in both 10nm and in its pathway to 7nm. PC growth seems better than expected and should drive growth. This is especially true given that, as management admitted on the Q3 call, Intel hasn’t been able to provide enough chips to meet current demand.
A meeting between Intel’s CFO and analysts this week supports that optimism. Morgan Stanley analyst George Davis wrote that Intel’s “process and design have returned to a much tighter level of coordination.” In other words, what Intel delivers in practice is much closer to what it plans on paper.
This matters, and it’s already mattered to Intel stock. The 2019 price-to-earnings multiple assigned Intel stock has expanded from roughly 10x at May lows to a current 12.5x. The lower multiple reflected a market legitimately worried that Intel’s earnings would decline. The current valuation, in contrast, prices in something like stability and admittedly still leaves room for upside if hopes for improved execution are valid.
Risks, Other Choices and Intel Stock
That remains a big ‘if’. One impressive quarter doesn’t offset several years of delays. Those delays have allowed rival Advanced Micro Devices (NASDAQ:AMD) to take share in CPUs and build out its own datacenter business.
AMD’s deal with Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) for chips in the Google Cloud business was a huge win for the smaller company and another loss for Intel. Nvidia (NASDAQ:NVDA) looms in datacenter as well. Both companies are (pardon the pun) chipping away at Intel’s near-monopoly in the category.
And the growth at those rivals raises another issue for INTC stock: why wouldn’t a semiconductor bull buy NVDA or AMD instead? Those stocks both are more expensive, obviously. And recent results for both companies show earnings and revenue declines.
But those declines are a result of the crypto bubble bursting; both companies should drive significantly faster growth going forward. If chip stocks outperform the market, those growth names likely will as well.
If an investor sees those stocks as too high, so-called “semicaps” like Applied Materials (NASDAQ:AMAT) and Lam Research (NASDAQ:LRCX) remain cheap on an earnings basis. Both stocks are plays on the same broader trend as INTC: growing chip demand thanks to trends like Big Data and the Internet of Things.
It simply seems like Intel stock has a narrow bull case at the moment. And while the stock is cheap, that doesn’t mean it’s without risk. We’ve seen INTC stock fall sharply twice in the last year. Execution worries remain.
Put another way, Intel is the biggest company in the semiconductor industry. But for several years, it hasn’t been the best, and Q3 earnings alone don’t fix that problem. Until it’s fixed, it’s going to be difficult for INTC stock to drive a sustainable rally from current levels.
As of this writing, Vince Martin has no positions in any securities mentioned.
