Intel: Short-term pains, long-term gains

Intel (INTC) has fallen behind the competition in technology over the past few years, leading many investors to believe that Intel is dead in the water. To course correct Intel, former CTO Pat Gelsinger returned to Intel as CEO in February 2021.

The groundwork is now underway to expand into the lucrative foundry business while continuing the core x86 processor business. The current macroeconomic and geopolitical climate is good for Intel. I’m bullish on Intel because of its long-term growth potential.

Expansion in the field of foundry

Historically, Intel has only designed and manufactured its own chips in its foundries. Intel is now opening up its foundries to third parties and expanding its capabilities.

The foundry business has huge barriers to entry; fortunately, Intel meets them. One of the biggest hurdles is access to the technology needed to create modern chips. Intel has an existing investment in ASML Holding (ASML), the only company to supply machines for lithography in the extreme ultraviolet (EUV).

ASML is also the only company producing the machines for High-NA EUV, which is expected to be used for Intel’s 18A process in 2025. Even though Intel has a 15% stake in ASML, it still has to order the machines for more. of $150 million. , showing how difficult it would be for a new player to get into modern chip manufacturing.

Intel is rapidly expanding its foundry capacity. Notable investments Intel has made to expand capacity include: investing €33 billion in operations across Europe, acquiring Tower Semiconductors for $5.4 billion, investing more than $20 billion in two new smelters in Ohio and $20 billion in two smelters in Arizona.

The expansion allows Intel to turn the threat of ARM and RISC-V architectures into an opportunity. Apple (AAPL) ditching Intel for its own Apple M1 chips was a blow to Intel. Intel could potentially win back Apple for manufacturing its ARM-based M1 chips.

The M1 chip is currently produced by Taiwan Semiconductor Manufacturing Company or TSMC (TSM). Apple switched to TSMC because TSMC is able to make a more efficient node. The Switch ultimately allowed Apple to have similar performance with longer battery life thanks to the top node and ARM architecture.

The crucial point for Intel to invest in foundries is whether it is unable to regain its technological dominance. If it can’t regain its dominance, high-end silicon customers like Apple will stay with TSMC. On the other hand, if Intel manages to dominate the industry, even its direct competitors Advanced Micro Devices (AMD) and Nvidia (NVDA) would likely flock to Intel’s foundries.

Intel has relied solely on improving other chip processes rather than downsizing raw transistors for years now. Intel’s density-free innovation is exemplified by the continuous improvement in performance of the 14nm transistor throughout its extended life.

One of the main introductions is the use of chips instead of the traditional monolithic system on a chip (SOC). Chiplets enable higher yields, reduce silicon wafer waste, and provide better optimization for specific uses.

In summary, Intel is preparing for the long term, investing heavily to grow its business.

Macro environment

The current macro environment is good for Intel. Geopolitical tensions and supply chain issues have prompted the US and EU to invest heavily in localizing semiconductor manufacturing.

It is estimated that TSMC, which is located in Taiwan, produces over 90% of the world’s advanced chips. China had a perpetual threat to invade Taiwan. A Chinese invasion is a threat to the international semiconductor industry. To defend against losing access to vital chips, the US and EU are looking to localize manufacturing.

The Innovation Act, which is making its way through Congress, would give the semiconductor industry $52 billion in funding. Intel would likely be the recipient of the lion’s share, as Biden praised the company during the Union speech. If passed, Intel will pour an additional $80 billion into its Ohio foundries for a total of $100 billion.

On the other side of the Atlantic, the European Union is pushing for 20% of total manufactured chips to come from the EU by 2030. The EU has a planned investment of $49 billion. As a result, Intel is investing €33 billion in manufacturing and research across the EU.

Intel is deepening its relationships with both sides of the Atlantic, which will enable long-term growth.

Investment financing

Due to rapid investment, CapEx reached an all-time high of $20.3 billion in 2021, a 40.7% year-over-year increase. The question is, can Intel keep spending?

Intel should be able to continue to invest heavily in expanding its foundry segment.

Intel had free cash flow of over $9.6 billion in 2021. The fact that Intel is able to maintain free cash flow positive after investing heavily is promising.

Intel is divesting its Mobileye self-driving business as an IPO. Mobileye is expected to be valued at over $50 billion. Intel is going to retain the majority of the shares, so it could sell up to $25 billion while retaining a majority. The cash injection will help pay for immediate investments.

As a last line of defense, Intel could lower its dividends and stock buybacks, but the market would penalize the stock price if that happens.

The bearish case against Intel’s financials is stagnant growth. Revenue was only up 1.5% year-over-year for 2021 and is expected to decline for the first quarter of 2022.

EPS is in worse shape than revenue; EPS fell 7.5% in 2021. Q1 2022 forecast shows a 40% drop in EPS for the quarter to $0.80.

The lack of growth is evident in the low P/E of 10.6.

Ultimately, Intel is pushing for long-term growth, but the trade-off is that short-term growth will most likely be negative or insignificant.

The Taking of Wall Street

As far as Wall Street is concerned, Intel is a hold base on eight buys, 13 holds and seven sell quotes over the past three months.

Intel’s average stock price target is $53.90, representing 4.9% upside potential.

Conclusion

Intel’s short-term stagnation should be compensated for in the long term. I’m more bullish than consensus analysis; I believe Intel is a buy.

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Michael J. Chiaramonte