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The Intel share is traded again and again on Twitter and various forums as an interesting turnaround story that could profit from the recently prevailing chip shortage. And indeed, the company recently invested heavily in order to turn things around operationally. However, the past quarter shows that the problems are quite deep and the company's management is setting a questionable focus. I'll save the most annoying part for last, from an investor's point of view.
A Disastrous Year - Sales and Profits Fall Sharply
Intel was unable to achieve either the targets it had set itself or those of the analysts. Instead of the expected 0.2 dollars per share, only 0.1 dollars could be achieved for the past quarter. In terms of sales, the company also fell far short of expectations, achieving $14.04 billion instead of the expected $16.27 billion. A look at the year as a whole also paints a disastrous picture.
Revenue fell by 20% to 63 billion, profit fell by 60% to 8 billion and operating profit fell by as much as 88% to $2.3 billion. The significant difference between operating and net income results from the sale of McAfee's shares last year. It is important to keep this in mind when looking only at Net Income, as this is not a repeatable effect.
The outlook for the coming quarter is also anything but rosy. For comparison, I have compared the figures from the first quarter of 2022. There is no guidance beyond Q1. Tends to be no sign of reliable results going forward either. Even if we assume the high end of guidance, revenue drops 37.5% to 11.5 billion. Profit slips significantly from just under $2 into negative territory at minus $0.8 per share, and there's even a special effect to consider.
Intel has increased the depreciation period for production machines and certain equipment from 5 to 8 years. There's nothing to be said against that if the machines actually last that long. We recently saw something similar with Amazon's servers. However, it has a strong positive effect on reported costs in the short to medium term, as depreciation is spread over a longer period. In 2023, a positive impact of about $4.2 billion is expected. Operating earnings increase by about $0.07 to $0.1 per share in Q1 due to lower depreciation and amortization. As I said, there is nothing to be said against this, but it should be considered when we look at the announced cost savings program at the end of 2023. However, CEO and CFO explicitly emphasized in the earnings call that the announced cost-saving measures apply independently of this effect.
Possible reasons for the negative development
If we were able to take away one thing in particular from the very detailed call that speaks for the poor operating performance from the perspective of the Management Board, then it is probably the macroeconomic situation. This is also an important aspect, but if we accept this explanation, it falls short of Intel's deeper problems. The company is indeed a 'victim' of the bullwhip effect. Buyers of Intel's products still have large inventories that they had built up as a result of past shortages and are now still reducing. According to CEO Pat Gelsinger, the picture in this respect should loosen up in the course of the year, which is also quite likely, since the effect should then weaken.
However, Intel also had to deal with other problems in the past few years. First and foremost, that the apparent upstarts took the butter off their bread. After more than 10 years of dominance over AMD in the CPU sector, the then significantly smaller competitor, at least in terms of market cap, increasingly gnawed at Intel's piece of the pie. In an overall market that is no longer growing rapidly, this is particularly painful for the market leader. There are signs that Intel can turn the tide here, but I stick to what I see as concrete results in the books, especially in the technical area, and that is not particularly promising for Intel at the moment.
However, as the Merrill Lynch analyst rightly pointed out, the CPU market is not the only one where Intel is having serious problems. The company is also losing market share to the competition in the data center sector, which is unusual in his opinion and only happens when the market leader really messes up. Here, too, AMD is actually making huge inroads, while Intel has had to accept further losses. According to Gelsinger, there are strong signs that the new "Sapphire Rapids" processors will change that, but I'll keep it as usual: I'll wait until I see it in the numbers, and so far only Intel's problem manifests itself there.
In general, the picture is ugly when we look at the individual segments. In the segments with strong sales, there is a strong decline or stagnation in sales across the board. Only Mobileye, which recently returned to the stock market, was able to convince with strong sales growth as well as operating income.
Net debt increases - free cash flow negative - dividend maintained
With the usual great admiration, I was able to hear the joy on Twitter about the fact that Intel is leaving the dividend at the same level as in the previous quarters despite the poor quarter. 0.365 dollars per share are to be distributed to the investors. I know that it is a nice feeling to get the quasi performance-free income paid into the account, but especially at Intel we should take a closer look. If the dividends stay at this level, we are talking about a cash outflow of $6 billion for the full year. Can the company afford this payout in good conscience in the current situation? I don't think so.
First of all, we can see that Intel is net debt. Cash and short-term investments of just under 28 billion are offset by debt of just under 42 billion. In my opinion, a dividend is not out of the question if the company generates a positive free cash flow and is not able to utilize the capital operationally. But that is not the case.
To calculate free cash flow, I take the reported operating cash flow as the basis and adjust for working capital movements and share-based compensations. Neither is entirely undisputed, but since free cash flow is not a GAAP measure, i.e. not subject to strict standards, I consider it essential to adjust the figures so that they are meaningful for investors. Regarding SBC, I had already written a detailed blog post written. In any case, this results in an operating cash flow of 16.8 billion for the full year. After deducting CapEx and payments on finance leases, this results in a negative free cash flow of 8.4 billion for 2022, compared with an enterprise value of around 130 billion.
Based on the statements of the CEO and CFO, a reliably positive free cash flow cannot be expected for the full year 2023 either. In view of this, is it justifiable to remove an additional 6 billion from the company 'without necessity' while financing the payout through debt and at the same time selling off the silverware? According to reports, capital expenditures will continue to be significantly higher than depreciation. Operationally required capital should remain in the company. That is my firm conviction. By the way, also very obliging of the executives to increase the SBC by 50% in the year-on-year comparison. This may not be the best signal to the investors.
Asked about the payout, CFO Zinsner said that the company would continue to pay an appropriate dividend and was very keen to utilize the capital in the interests of the investors.
Intel should be given credit for investing very heavily in growth. Investments are significantly higher than depreciation. High amounts in the billions flow into research as well as the expansion of production capacity. Consequently, the company cannot be said to be in a state of shock.
Conclusion
I'm always tempted to illuminate light and shadow in equal measure. In the case of Intel, I find it difficult to find anything on the light side. The company is losing market share, has to continue to invest heavily, is taking on debt to pay the dividend, and all this in a rising interest rate environment. It's foreseeable that the rest of the year won't be quite as bleak as Q1, but it's not just macroeconomic conditions that are causing Intel trouble. This becomes clear when looking at the peers, which are coming through the current situation much better. Intel's products are clearly not without competition and the capital allocation in view of a negative free cash flow gives cause for criticism in my opinion. In my view, the company is not attractively enough priced for a turnaround play, so I am keeping my distance from the stock. Whether the dividend can be maintained also remains questionable.
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