INTC in Volatile AI Trade: CPU & U.S. Tailwinds Face Slowing Buildout

George Tsilis (0:04)

All right, thanks and welcome back to the Tech Corner. I'm George Tsilis, Senior Markets Contributor here with the Schwab Network. Now, in this week's edition, we're going to be revisiting Intel Incorporated. Now, as many of you may know, Intel is a leading global provider of computing related technology products and services. It operates through three primary segments. Its client computing group includes PC, CPUs, chipsets, integrated graphics, and now AI-enabled client platforms. The data-centered group includes Xenon server CPUs, AI accelerators for networking solutions, and related software stacks for cloud enterprise and telecom communications providers. Now, Intel's Foundry Division is a leading-edge, specially processed technology manufacturing service, which also provides packaging for Intel, as well as external semiconductor customers. The company also supports a wide array of semiconductor products, including microprocessors, chipsets, GPUs are also called graphics processing units, field-programmable chips, as well as other semiconductor components. Now, in the competitive landscape, we have to consider other known companies such as AMD.

They compete in CPUs and GPUs, as well as PC servers and data centers.

NVIDIA incorporated, they compete in data center GPUs, as well as AI accelerators. Broadcom, also in networking and custom application-specific integrated circuits. Qualcomm, in select compute and edge markets. And Taiwan Semiconductors, which is the dominant Foundry rival to Intel's manufacturing ambitions. Now, the unique value proposition for Intel lies in its comprehensive portfolio that spans CPUs, GPUs, advanced packaging, as well as Foundry services. It is the only US-based company currently conducting both leading edge, logic research, and high-volume advanced logic manufacturing in the United States. The company is leveraging its extensive manufacturing capabilities, including advanced nodes like Intel's 18A, to differentiate itself from competition. Lastly, the company also remains deeply embedded across global PC and server ecosystems, giving it an enormous install base for new AI-related processors, enterprise workloads.

Now, let's take a look at some recent news for Intel. Going back to late October, the company reported its third quarter revenue as well as EPS numbers.

Revenue reached approximately $16.5 billion, up 21 percent year-over-year. On a non-GAAP basis, EPS reached 52 cents, which was more than double than the previous year, but also had expectations which were around 40 cents a share. On a non-GAAP gross margin basis, that improved to 44.1 percent from 40 percent a year earlier. Now, the standout metric was data center and AI. The revenue in this division reached $7.3 billion, up 78 percent year-over-year. Intel described the quarter as its strongest data center revenue growth in roughly 15 years. Demand for Xenon CPUs has been so strong that Intel has actually been unable to supply all of the available demand. However, there was one sticking point in the call. The PC business was much weaker. Client computing and physical AI revenue declined 5 percent to approximately 8.1 billion. Intel said PC volumes fell approximately 14 percent year-over-year as high memory prices, higher component costs, and competitive pressures weighed on demand. The bigger problem came from the outlook. Intel lowered its fourth quarter guidance to between 15 and 16 billion dollars from 17 billion dollars and also adjusted EPS guidance of 25 cents, which was well below the consensus of 43 cents for the quarter. Therefore, that weak outlook triggered the enormous stock reaction. Intel shares fell approximately 29 percent the following day after earnings, as investors focused on slowing PC demand, supply constraints, higher capital requirements, and weaker cash flow rather than the strong reported quarter. Now, let's take a look at some other positives for Intel. One of the strongest parts of Intel story is the renewed importance of Xenon CPUs and AI infrastructure.

AI data centers still require large number of CPUs for orchestration, data processing, networking, and general purpose computing even when CPUs perform the primary AI acceleration. Foundry cost structure has improved marketably for the company. With Intel 18A manufacturing cost down 40% since Q1, this is supporting progress towards a competitive and more sustainable manufacturing process and narrow operating losses in the segment. As I mentioned before, the AI data center segment grew 78% with this particular segment's operating profits reaching nearly $3 billion and robust operating margins indicating growing momentum for AI and server demand. Now going forward in the next four quarters, revenue is expected to improve to around 9% versus revenue over the last five year average down 1.4%.

Forward profitability is also expected to improve. If we look at EBITDA growth estimates are around 32% of sales, which indicates a meaningful profitability pivot compared to EBITDA growth over the last five year on average of around 1.5%.

Finally, another puzzle we have to consider is Intel has a substantial strategic importance to the United States semiconductor manufacturing industry. The US government owns approximately 9.9% of Intel, and the company continues to invest heavily in domestic fabrication capacity. That government backlog does not guarantee financial success, but it does strengthen Intel strategic position within the US semiconductor policy. Now, despite the positives I mentioned, let's address some of the concerns as well as always. The biggest near-term concern is the disconnect between strong data center demand and Intel's ability to actually supply it. Manufacturing bottlenecks, substrate shortages, and other component constraints are preventing the company from fully taking advantage of the demand for Xenon processors. At the same time, high memory prices are having the opposite effect on PCs by making computers more expensive and reducing demand. Despite foundry business growth, that division remains deeply unprofitable with minimal external revenue. The segment generated around $6.1 billion in revenue for the quarter, but most of that business still comes from manufacturing for Intel itself rather than for outside customers. The external foundry revenue was only about $411 million for the quarter, and that's the division still generated an operating loss of approximately $1.85 billion.