Shares of Intel (INTC) dropped over 10% following their just reported earnings. We were asked about our thoughts on the stock at $49, and we opined that we felt it was going to trickle lower. Based on valuation, the dividend, and projections from the company, we believe under $45 you can hold your nose and buy. We think the market will push it lower. This is especially true if the overall market rolls over in the coming weeks with the lack of stimulus passage, or a contested election. Tech as a whole has been weak the last few weeks as well, keep that in mind, relative to other sectors that have been catching a rotational bid. Now here is the thing. The reported quarter from Intel was actually pretty decent, even if compared to expectations it was not great, and even if relative to the competition it is lagging. Overall, the stock is a hold, but another 10% or so lower, and this belongs in your long-term dividend portfolio. But it is not there yet. Let us discuss.
On surface, the quarter was good. Coming into the quarter, Intel had five straight quarters of sizable beats versus consensus, especially on the revenue front. Here in Q3, revenues beat expectations. And earnings were in line. But obviously, markets do not care just about the headlines. That said, the quarter was led by strong consumer notebook demand and continued cloud growth, and the company generated $18.3 billion in revenue and delivered $1.11 in EPS. While CPUs are foundational to Intel’s business, the company is also adding a range of other processing engines or XPUs to its portfolio. It has also made great strides in graphics and is now scaling its graphics architecture from integrated to discrete levels of performance. However, the concern is things are behind the competition.
So, what is the problem? The market was really displeased with the data centric revenues. Data-centric revenue was $8.5 billion, down 10% year over year on COVID-related weakness. PC-centric revenue was $9.8 billion, up 1% year over year on the strong aforementioned notebook PC demand in consumer and education segments and on increased supply. Gross margin for the quarter was 55%, two points below expectations due to lower data center ASPs, driven by mix shift from enterprise and government to cloud and lower PC client ASPs on increased demand for consumer and education PCs. That is a major problem.
True pain was felt in the Data Center Group where revenue of $5.9 billion was down 7% from the prior year. COVID-driven headwinds significantly impacted enterprise and government segment, which was down 47% year over year following two consecutive quarters of more than 30% growth. A bright spot here? Cloud and comm service provider segments were up year over year 15% and 4%, respectively.
Shares are getting obliterated. As the company struggles to keep pace with shifts in demand, and to innovate relative to competition, we believe shares a are a hold until they are below $45. That would be a buy level. This is because forward guidance is not too bad.
As we look ahead, Intel sees Q4 revenues at $17.4 billion, compared to analyst consensus estimates of $17.39 billion. That was positive. In addition, management see EPS coming in at $1.10 versus a consensus expectation of $1.02. That means there is value here, right? Well, there is, but only if growth can continue going forward. The problem with lower sales is that margins on a sequential basis may take a hit. However, the company is killing it on the buyback, on top of revenue guidance being raised from $75 billion to $75.3 billion, with the adjusted EPS forecast now at $4.90. We are buyers at 9X 2020 EPS if it gets there.
The company also expects to generate $18.0 billion to $18.5 billion of free cash flow in 2020, up from $17.5 billion. There are still a lot of positives here. Keep in mind the cash flow is being used for an accelerated share repurchase agreement to repurchase $10 billion in stock, further boosting future EPS.
To get out of this funk, the Street wants to see meaningful moves to innovate, improve margins, and compete. However, the decision to sell off its memory business shows that Intel has no plans on innovating. And for that, with the performance it is likely to put up, you cannot buy shares here unless they drop about another 5 points in our opinion to account for this. The post-earnings decline was warranted. But there is more pain ahead.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.