Intel (NASDAQ:INTC) stock sank in late October after the CPU giant reported third quarter numbers that were less than inspiring.
Earnings included some big red flags, namely a 10% revenue drop in the company’s once burgeoning data-centric business and a 600 basis point drop in gross margins. And those red flags are a big deal for two reasons.
One, a large part of the bull thesis on INTC stock over the past few years has been Intel’s pivot from a PC-centric business to a data-centric business. The surprise drop in the data-centric segment for Q3 is a big knock on that overarching bull thesis.
Two, increasing competition from Advanced Micro Devices (NASDAQ:AMD) and others has pressured Intel’s margins for several years. While this pressure was supposed to ease as Intel fought back against competitors, market share has actually only gotten worse.
Needless to say, following Intel’s third quarter earnings report, the bear thesis on Intel stock looks pretty compelling. That is, most evidence today does point to the fact that you have a slow-moving CPU incumbent that is rapidly being passed up by more innovative competitors.
But I also think that this bear thesis lacks scope and is unnecessarily short-sighted.
In the big picture, most of Intel’s current headwinds are transient. Intel will ultimately bounce back over the next few years and strongly defend its global CPU leadership position. Revenue and margin trends will improve, and profits will bounce back.
As all that happens, INTC stock — which is significantly undervalued today due to competition concerns — will rebound in a big way.
Intel’s Bad Earnings
Intel may have topped Q3 revenue estimates and narrowly lifted its full-year guide. But make no mistake. Intel’s earnings were not good.
At issue, the company’s once burgeoning data-centric business — which grew revenues by 34% in each of the previous two quarters — stopped growing in the third quarter, with revenues falling 10% year-over-year. That’s not a great sign, because that business is the future of Intel, and Intel has a ton of competition in that segment from the likes of AMD and Nvidia (NASDAQ:NVDA).
So the fact that Intel went from growing at breakneck speed to declining revenues in a matter of months is not a great sign for the future of Intel. It gives broader credibility to the idea that, as Intel expands more aggressively into more competitive end-markets, the company is losing to AMD and Nvidia.
Even further, gross margins declined 600 basis points in the quarter, mostly because Intel’s customers shifted their demand from premium, high-margin chips, to economic, low-margin chips amid the pandemic. Again, that’s not a great sign, because it basically says that whatever business Intel is winning in the CPU game today, is lower quality business.
Overall then, Intel’s third quarter earnings report was not good, and it makes complete sense that INTC stock crashed after the release.
Zooming out, the headwinds bogging down Intel today are transient in nature.
Rising competition will always be a problem. But Intel has so much more manpower, resources and experience than anyone else in the CPU game. The company should be able to leverage those advantages to formidably defend its leadership position over the next few years. So, while Intel may never again enjoy a monopoly of the CPU space like it did five years ago, the company will forever remain a very important player in this market.
And losing “monopoly” status is just fine, because the semiconductor market is on the cusp of enormous growth throughout the 2020s, as we increasingly pivot to a technology-driven society built on the back of CPU chips. So long as Intel stabilizes market share in that booming market, revenue growth trends will remain healthy.
Meanwhile, gross margin pressures will ease as Intel finally scales 7-nanometer chip production in 2022. Brining these chips to market will help Intel win back higher-quality, higher-margin business, and will therefore, provide a material boost to the company’s overall gross margin profile.
Big picture: Intel is down, but certainly not out. Over the next few years, this company will bounce back from what appears like a very precarious position today. As it does, INTC stock will rebound with vigor.
Big Upside Potential for Intel Stock
Because of overarching competitive concerns, Intel stock is dirt cheap today.
The company is calling for $4.90 in earnings per share this year. The INTC stock price today is $48. That means this stock is trading at a measly 10-times 2020 earnings multiple. For comparison, the S&P 500 is trading at 26-times 2020 earnings estimates.
This dirt cheap valuation exists exclusively because of fears that Intel will forever cede market share to AMD. But that won’t happen. As those fears disappear in the coming quarters, this anemic valuation on Intel stock will disappear, too.
My numbers imply that Intel stock has fundamentally supported upside to $66 in 2021. That represents nearly 40% upside from current levels.
Bottom Line on INTC Stock
Intel stock looks like a tough buy right now. But it’s the right buy, because today’s transient headwinds will ultimately give way to much more structural tailwinds.
As they do, depressed and undervalued INTC stock will rip higher.
On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article.
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