Can Intel Survive Chipped Demand?

 Intel (INTC) reported fourth-quarter results that were within our range of expectations, as softness in the PC market created headwinds for the firm during the quarter. We will likely either maintain or slightly lower our fair value estimate by roughly 5%.

For the quarter, revenue was $13.5 billion, about flat sequentially, but down from $13.9 billion in the year-ago quarter. The fourth quarter is typically a seasonally strong one for Intel, but the firm was affected by the recent pressures on the PC market caused by both a weak macroeconomic environment and the rapid adoption of tablets. The slowdown in global PC demand, and the subsequent drawdowns of chip inventories along the PC supply chain by computer manufacturers, hampered PC microprocessor sales. As a result, Intel's PC processor segment saw revenue decline 1% quarter over quarter to $8.5 billion. The firm's server processor business posted revenue of $2.8 billion, an increase of 7% from the third quarter. While that segment saw growth in server chip sales for cloud applications and got a boost from a richer product mix, these benefits were somewhat offset by weaker server processor demand from enterprises because of the soft economic conditions.

On the profitability front, gross margin came in at 58.0%, down from 63.3% in the third quarter. Intel caused the drop by reducing production in order to lower inventories, and by redirecting manufacturing equipment for the upcoming 14-nanometer (circuit size) chip-fabrication process. This hurt profitability given the high fixed costs associated with semiconductor manufacturing plants. Additionally, the firm began production of soon-to-be-released Haswell processors, which requires inventory write-offs of the new chips until they are qualified for sale. Operating income came in at $3.2 billion versus $3.8 billion last quarter.

For the second quarter, management expects sales to be between $12.2 billion and $13.2 billion, which would indicate a 6% decline at the midpoint and would be roughly in line with typical seasonal trends. For full-year 2013, management noted that it expects Intel to see revenue grow in the low-single digits, which is in line with our prior expectations. This forecast includes anticipated low-double-digit growth for the firm's server chip business. While it provided no number for the PC processor segment, management noted that it expects to see some growth there.

Although Intel is facing some headwinds to its PC processor business, we believe the firm as a whole can grow over time. In the PC processor segment, the PC market is facing some cannibalization from tablets, but we believe that some of the pressures have also been economic in nature. In the past few years, emerging countries have primarily been driving PC unit growth, but demand from these markets has softened with the recent economic uncertainty. As the economic situation improves, we think recoveries in emerging markets could support some growth in the PC market down the road. More important, Intel's server processor segment is poised for solid longer-term growth, as the proliferation of smartphones and tablets requires cloud infrastructure build-outs that will drive demand for server chips. Despite this opportunity, we think that investors in general have been under-appreciating the prospects of this business. Finally, while we currently don't forecast much success from Intel in the smartphone and tablet processor space, the firm's Atom products for this market are becoming more competitive with incumbent  ARM Holdings in terms of power efficiency and could potentially provide some significant upside opportunities for Intel in the future.

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