Intel: Short-Term Pains, Long-Term Gains

Intel (INTC) has fallen technologically behind the competition over the last few years, which has led many investors to believe Intel is dead in the water. To correct Intel’s course, former CTO Pat Gelsinger returned to Intel as CEO in February 2021.

The groundwork is now being done to expand into the lucrative foundry business while continuing the core x86 CPU business. The current macroeconomic and geopolitical climate is beneficial for Intel. I am bullish on Intel because of its long-term growth potential. 

Expanding into the Foundry Business

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 capacity.  

The foundry business has enormous barriers to entry; luckily, Intel meets them. One of the key barriers is access to the technology needed to create modern chips. Intel has an existing investment in ASML Holding (ASML), the only company to provide machines for extreme-ultraviolet lithography (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 back order the $150+ million machines, showing how difficult it would be for a new player to start manufacturing modern chips. 

Intel is rapidly expanding its foundry capacity. Some of the notable investments Intel has made to expand capacity include: investing €33 billion into operations across Europe, acquiring Tower Semiconductors for $5.4 billion, investing over $20 billion into two new foundries in Ohio, and $20 billion for two foundries in Arizona. 

The expansion allows for Intel to turn the threat of ARM and RISC-V architectures into an opportunity. Apple (AAPL) dropping Intel for its own Apple M1 chips was a major 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 manufacture a more effective node. The switch ultimately allowed Apple to have similar performance with more battery life due to the superior node and ARM architecture. 

The crux of Intel investing in foundries is if it is unable to regain technological dominance. If it can’t regain dominance, high-end silicon customers like Apple will remain at TSMC. On the other hand, if Intel is able to gain industry dominance, even direct competitors Advanced Micro Devices (AMD) and Nvidia (NVDA) would likely flock to Intel foundries. 

Intel has relied purely on improving other chip processes over raw transistor size reductions for years now. Intel’s non-density innovation is illustrated by continuing performance improvements on the 14nm transistor over its extended lifetime. 

One of the key introductions is the use of chiplets instead of the traditional monolithic system on a chip (SOC). Chiplets allow for better yields, reducing wasted silicon wafers and offering better optimization for specific uses. 

In summary, Intel is setting itself up for the long game, investing heavily to expand its business. 

Macro Environment

The current macro environment is beneficial to Intel. Geopolitical tensions and supply chain issues have pushed the U.S. and EU to invest heavily in localizing semiconductor manufacturing. 

TSMC, which is located in Taiwan, is estimated to produce more than 90% of the world’s advanced chips. China has 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, both the U.S. 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 be the likely recipient of the lion’s share as Biden praised the company during the Union Address. If passed, Intel will pour another $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 chips manufactured to come from the EU by 2030. The EU has a planned investment of $49 billion. As a result, Intel is investing €33 billion into fabrication and research across the Union. 

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

Funding Investments

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

Intel should be able to continue to have heavy investment into expanding its foundry segment.

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

Intel is spinning off its autonomous driving business Mobileye as an IPO. Mobileye is expected to be valued at more than $50 billion. Intel is going to retain a majority of 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 would be able to drop its dividend and share buybacks, but the market will punish the stock price if this occurs. 

The bearish case against Intel’s finances is the stagnation of growth. Revenue only grew 1.5% year-over-year for 2021 and is expected to drop for Q1 2022.

EPS is in a worse state than revenue; EPS fell 7.5% in 2021. The Q1-2022 guidance shows a 40% decline in EPS for the quarter to $0.80.

The lack of growth is exhibited 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. 

Wall Street’s Take

Turning to Wall Street, Intel is a Hold base on eight Buys, 13 Holds, and seven Sell ratings over the last three months. 

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

Conclusion

Intel’s short-term stagnation should be made up for in the long term. I am more bullish than analysis consensus; I believe Intel is a Buy. 

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