With Less Conviction on Its Turnaround Strategy, We’re Downgrading Intel’s Moat to Narrow

We are lowering our moat rating for Intel (INTC) to narrow from wide, as we are no longer certain that the firm can generate excess returns on capital over the next few years. In concert with our moat rating downgrade, we are lowering our fair value estimate for Intel to $50 per share from $56 per share, as we reduce the time frame we expect Intel to generate excess returns on invested capital with certainty. Our moat downgrade concedes that Intel’s recent financial performance and execution was worse than our prior expectations. However, our outlook for Intel has not materially changed, as we remain positive on Intel’s IDM 2.0 strategy to get its manufacturing back on track (which will support more competitive products). We still view shares as undervalued for long-term, patient investors but acknowledge that the next several quarters will be highly tumultuous for the firm.

We still believe Intel possesses cost advantages realized in the design and manufacturing of its cutting-edge microprocessors and intangible assets related to its x86 instruction set architecture license and chip design expertise. However, we believe Intel’s cost advantage has eroded, as it faced significant product delays associated with its various 10-nanometer process technologies. Intel’s x86 rival, AMD, and its foundry partner, Taiwan Semiconductor Manufacturing, or TSMC, have combined to leapfrog Intel in cutting-edge processors. In turn, in recent years, Intel has lost market share, conceded on pricing, and faced a sharp decline in gross margins and returns on invested capital. We believe that it is more likely than not that Intel can close the gap with TSMC/AMD and generate excess returns on capital over the next decade, but this is no longer a certainty, and we concede that Intel’s manufacturing inferiority to TSMC/AMD will persist for the next year or two and perhaps longer.