The Intel (INTC) Conundrum: When Will the Bleeding Stop?

Prominent chipmaker Intel Corporation’s (INTC) shares plunged more than 14% over the past five days. This downward trend follows the revelation that Intel incurred a significant operating loss of $7 billion last year for its chip-manufacturing unit, also called the foundry business, about 35% worse than in 2022. The unit reported revenue of $18.90 billion for 2023, down 31% year-over-year.

During an investor presentation, INTC’s CEO Patrick Gelsinger discussed the company's projections, stating that 2024 would likely mark the peak of operating losses for its chipmaking division. He mentioned that Intel anticipates reaching break-even on an operating basis by around 2027.

Pat Gelsinger further acknowledged challenges in the company’s foundry business, attributing to poor decisions, including one year ago against extreme ultraviolet (EUV) machines from the Dutch company ASML Holding N.V. (ASML). Although these machines can cost more than $150 million, they are considered more cost-effective compared to earlier chip-making tools.

Partially due to these missteps, Intel has outsourced approximately 30% of its total wafer production to external contract manufacturers like TSMC, Gelsinger added. The company’s goal is to lower this number to around 20%.

Additionally, the semiconductor giant has now transitioned to using EUV tools, which are expected to handle an increasing portion of production requirements as older machinery is phased out.

“In the post EUV era, we see that we're very competitive now on price, performance (and) back to leadership,” Gelsinger stated. “And in the pre-EUV era we carried a lot of costs and (were) uncompetitive.”

However, on a negative note, investment bank Bernstein analysts recently remarked that there is no compelling reason to hold Intel stock until 2030.

Bernstein recognizes the potential for improvement in Intel’s foundry business, given the significant loss incurred last year and the optimistic projection for achieving a 25-30% operating margin by 2030.

However, analysts cautioned, suggesting that the road ahead for INTC might be challenging, even with the seemingly ambitious targets. They noted that reaching break-even may not happen until after 2027, and the ambitious goals set for 2030 are speculative and dependent on achieving optimal progress, which remains a topic of debate.

In the last reported earnings, INTC surpassed analysts’ estimates on revenue and EPS. However, the chipmaker announced a weak forecast for the current quarter. For the quarter that ended December 31, 2023, INTC’s net revenue increased 10% year-over-year to $15.40 billion. This surpassed the consensus revenue estimate of $15.17 billion.

Also, net income attributable to Intel was $2.70 billion, compared to a net loss of $700 million in the previous year’s period. The company reported an EPS of $0.63, compared to analysts’ estimate of $0.22, and a loss per share of $0.16 in the same quarter of 2022.

However, as of September 30, 2023, the company’s cash and cash equivalents stood at $7.07 billion versus $11.14 billion as of December 31, 2022.

Intel’s fourth-quarter 2023 report marked a return to growth after eight consecutive quarters of decreasing earnings and seven straight quarters of declining sales on a year-over-year basis. But for the first quarter, the chip company projected adjusted EPS of just $13 on sales of $12.70 billion. Analysts expect earnings of $0.14 per share on revenue of $12.78 billion.

During an earnings call, Intel CEO Patrick Gelsinger stated that the company’s first-quarter sales would be impacted by difficulties at Mobileye, where Intel holds a majority stake, and in its programmable chip unit.

Gelsinger also mentioned that Intel’s core businesses, particularly PC and server chips, were performing strongly, with sales expected to fall within the lower end of the seasonal range.

On March 21, INTC announced plans to invest $100 billion in constructing and expanding chip factories across four states in the U.S., following securing $19.50 billion in federal grants and loans and wishes to secure another $25 billion in tax breaks.

Intel’s primary focus in its five-year spending plan is to convert undeveloped land near Columbus, Ohio, into what CEO Pat Gelsinger described as “the largest AI chip manufacturing site in the world,” with potential commencement in 2027.

In addition, the chip giant intends to revamp sites in New Mexico and Oregon while expanding its presence in Arizona. This initiative aligns with rival Taiwan Semiconductor Manufacturing Company Ltd. (TSM) construction of a massive factory in Arizona, leveraging President Joe Biden's efforts to bolster advanced semiconductor manufacturing in the U.S.

Intel was at the forefront of the semiconductor industry for decades and was known for producing the fastest and smallest chips. The company commanded premium prices for its products and reinvested its profits into continuous research and development (R&D), aiming to stay ahead of its competitors.

However, in the 2010s, INTC’s manufacturing superiority waned, particularly in comparison to TSM. This shift resulted in a significant drop in profit margins as Intel had to lower prices to maintain its market share, even though its products were perceived as less competitive than its rivals.

In 2021, Gelsinger unveiled a strategy to restore Intel to its former top position in the semiconductor market, acknowledging the necessity of government support to ensure the plan’s profitability. With the federal support secured, the chipmaker is now gearing up for substantial investments.

Gelsinger mentioned that approximately 30% of the $100 billion budget will be earmarked for construction expenses, covering labor, piping, and concrete. The remaining funds will be utilized to acquire chipmaking tools from firms like ASML, Tokyo Electron, Applied Materials, Inc. (AMAT), and KLA Corporation (KLAC), among others.

Moreover, Intel's strategy for business turnaround hinges on persuading external companies to use its manufacturing services. In February, INTC announced that Microsoft Corporation (MSFT) plans to use its services to manufacture a tailored computing chip. Moreover, the company expressed optimism about exceeding its internal target of surpassing TSM in advanced chip manufacturing before 2025.

As a part of this plan, INTC recently told investors it would start reporting the results of its manufacturing operations as a separate unit.

Intel’s new reporting structure, effective from the first quarter of 2024, includes operating segments such as Client Computing Group (CCG), Data Center and AI (DCAI), Network and Edge (NEX), Intel Foundry, Altera (now Intel’s Programmable Solutions Group), Mobileye, and Other. CCG, DCAI, and NEX will be collectively known as Intel Products, while Altera, Mobileye, and Other will be referred to as All Other.

The newly established Intel Foundry segment, including foundry technology development, foundry manufacturing and supply chain, and foundry services, will recognize revenues generated from external foundry customers and Intel Products, along with technology development and product manufacturing costs historically allocated to Intel Products.

Intel’s CFO, Dave Zinsner stated, “This model is designed to unlock significant cost savings, operational efficiencies and asset value. As it begins to take hold, we expect to accelerate on our path toward achieving our ambition of 60% non-GAAP gross margins and 40% non-GAAP operating margins in 2030. Ultimately, improved cost competitiveness will help us deliver process technology, product, and foundry leadership while driving significant financial upside for Intel and our owners.”

Bottom Line

Last week, INTC confirmed its intention to separate the financial results of its foundry business, providing investors with a closer look at its historical performance. However, the revealed figures were disappointing: the foundry business suffered losses of nearly $7 billion in 2023, a 35% increase in losses compared to 2022, alongside a 31% decrease in sales.

Along with these figures, the company stressed that the new financial reporting structure is designed to boost cost discipline and higher returns by offering enhanced transparency, accountability, and incentives across the business. Moreover, this transition is expected to unlock unrealized value across Intel’s about $100 billion in capital assets.

Last month, Intel unveiled plans to spend those $100 billion on building or expanding chip factories in four U.S. states. As part of its turnaround strategy, the chipmaker aims to convince external companies to utilize its manufacturing services. The company has been heavily investing to compete with its main chipmaking rivals, including TSM and Samsung Electronics Co Ltd.

Despite Intel’s optimism about turning the business around and achieving break-even by 2027, with a projected adjusted operating profit margin of 30% by 2030, analysts, including those at Bernstein, are cautious. They view Intel’s forecast as overly ambitious, suggesting that actual margins might only reach 25% by 2030.

Further, CNBC’s Jim Cramer advises investors to avoid investing in Intel despite the company’s turnaround plans.

While INTC is actively pursuing its turnaround initiatives, it currently encounters significant challenges, including underperformance within its foundry business, fierce competition, and cash burn. So, it could be wise to steer clear of this stock now.