Chipmaker Intel Corp. (INTC, Financial) was able to surpass Wall Street's earnings estimates for the third quarter, but disappointed investors with its outlook for the coming quarter. Executives of the Santa Clara, California-based company said its profitability will suffer over the next several years as it increases spending dramatically to improve the technology used in the chip fabrication process, news that was not music to the ears of investors. The result was a 10% decline in the share price.
All eyes on the turnaround story
New CEO Pat Gelsinger, who originally joined the company as a teenager before leaving in 2009, has already introduced long-term plans to ramp up investments in Intel's products and competitive manufacturing strategies despite their negative impact on short-term earnings. When he started as CEO last February, Intel had already lost its stability and leadership position from an innovative perspective in the semiconductor industry, which was the reason behind his pledge to re-engineer the company in terms of quality and new investment in foundries that will even offer outsourced services to other chip designers in the future. Yet, investors are closely keeping an eye on the CEOs' ability to improve Intel's products quickly enough to avoid market share losses to rivals and to retain customers who are beginning to design their own components.
Third-quarter performance is encouraging
The third quarter marked the first quarter in which the company returned to revenue growth after four consecutive negative quarters. Net income came in at $6.82 billion, or $1.67 per share, on revenue of $19.2 billion. The gross margin was 56% (a 2.9% increase year over year), compared with an average estimate of 55%. Sales, excluding the memory chip business that Intel is spinning off to SK Hynix (XKRX:000660, Financial), came to $18.1 billion, an increase of 5% year over year. The company experienced record revenue growth of 54% from its internet of things business segment and 39% growth in the Mobileye segment, which accounts for the automotive chip subsidiary. In the crucial data center business, revenue from cloud service providers dropped 20%, which is concerning.
From a capital expenditures perspective, Intel expects to spend $18 billion to $19 billion for the current financial year, including its investment in a new chip foundry in Arizona. Despite investor concerns, the company is expecting to continue its capital spending spree in the near future and plans to spend $25 billion to $28 billion in 2022 for this purpose. Intel expects the gross margin to range between 51% and 53% in the next two years before beginning to improve thereafter because of the expected cost savings resulting from these investments.
Many challenges are looming on the horizon
Some of Intel’s top clients, such as Amazon.com Inc. (AMZN, Financial) and Microsoft Corp. (MSFT, Financial), are designing chips for themselves, creating concern that the company could permanently lose some of that business. This threat needs to be assessed carefully by Intel investors as we could be at a turning point in the history of the semiconductor industry given that big tech companies seem to be serious about developing chips on their own to avoid being victims of semiconductor shortages in the future.
Intel also announced that Chief Financial Officer George Davis will retire in May of 2022. He is one of the few top executives retained by Gelsinger. Although this is not a cause for immediate concern, investors should ideally monitor the risk of Intel losing high-quality talent to competitors as it would be an early sign of future troubles for the company.
The increasing competition in the industry is another challenge for Intel to retain its share of the global semiconductor market. Taiwan Semiconductor Manufacturing Co. Ltd. (TSM, Financial) is already boasting about its processors’ capacity to perform better than Intel’s, and the latter will have to up its game sooner rather than later to ensure its most important customers are not lost to competitors.
Global supply chain issues are making it difficult for Intel to get back on track as well. The company has already blamed the industry-wide component shortage for having a negative impact on corporate earnings. In an interview, Gelsinger said this situation will improve every quarter next year, but that the ongoing supply-demand imbalance will not be fully resolved until 2023.
Takeaway
Intel has a long way ahead of it to once again regain its dominance in the global semiconductor industry. Although the company is moving in the right direction, shareholders should ideally be prepared for a tough few quarters as the company will be forced to sacrifice its short-term profitability to invest millions of dollars to expand manufacturing capabilities.
