TSEM - Intel Corporation: Watch The Balance Sheet

2023-05-02 16:15:46 ET

Summary

• Intel Corporation's first quarter results were a bit stronger than feared.
• The Intel second quarter outlook suggests that real stabilization is seen in the business.
• This is very much welcomed as free cash flows are hugely negative.
• Stronger commercial traction, even at lower levels, is offset by Intel Corporation balance sheet deterioration, making me a bit cautious after a recent run-up in the shares.

In February, I wondered what was in store for shares of Intel Corporation ( INTC ) as the company cut its dividend by two-thirds, in a move which did not surprise me at all. In fact, the dividend should have been cut earlier in my opinion, and perhaps been cut even more.

With dividend investors selling on the news, I saw the opportunity for a near-term bounce, certainly as valuations were coming down while the Mobileye Global Inc. (MBLY) stake was getting more valuable, although I lacked conviction given the outlook.

Intel's Woes

Troubles for Intel started in 2020, when it announced an initial 6-month delay in the product development of its 7nm product line-up. This granted Advanced Micro Devices, Inc. (AMD) a huge opportunity to take away (even) more market share. This created a double whammy for the business, as the company saw a slowdown in 2022 like the rest of the market, but was seeing competitive pressures on top of this as well.

Recognizing the issues, Intel re-hired veteran Pat Gelsinger as CEO early in 2021, although it was clearly understood that this was a long-term and tough turnaround process. For the year 2021, sales rose a percent to $7 billion as net earnings were down from $5.30 per share to $4.86 per share, equal to $20 billion in actual dollar terms, with net debt of $3 billion being largely flattish.

The company has seen tough 2022 results on the back of the loss in competitiveness and general woes in the semiconductor sector, with sales down 7% in the first quarter, down 22% in the second quarter and trends deteriorating from there.

With more pressure seen in the fourth quarter results, breakeven levels were coming in sight as the company announced large layoffs to cut costs and reduce its break-even point. For the year 2022, Intel reported a 20% decline in full year sales to $63.1 billion. That was only part of the story, though, as higher expenses, lower sales and lower gross margins meant that net profits fell 60% to $8.0 billion. This lower profitability, buybacks, and continued dividends meant that net debt rose to $14 billion over the past year.

With the company posting poor fourth quarter earnings, Intel was in for a challenge as net capital investments trend around $10 billion, with the dividend trending at another $6 billion a year, resulting in a large built up in net debt over time. The company had a wildcard in its books, as it still held a 94% stake in Mobileye, which earlier this year was valued at $41 per share, as the stake of Intel was still valued at around $35 billion.

So while I applaud the Intel move to cut the dividend, I recognize the risks as well as Intel only guided for first quarter sales around $11 billion, with adjusted losses seen around $0.15 per share, but moreover few reasons were present to turn more upbeat on the business and its prospects.

Given this outlook, a 66% cut in the quarterly dividend to a rate of $0.125 per share was long overdue and welcomed as shares fell from $28 to $25 with dividend searching investors bailing on the stock. While Mr. Gelsinger sounded upbeat on product launches in 2023 and 2024, it was the same dividend cut which in essence was an admission that a turnaround would not be seen soon. That said, the valuation of Mobileye provided a lifeline, yet I lacked conviction to add to a current position.

Stabilizing

Amidst a recovery in the wider market, share of Intel have risen from $25 in the aftermath of the dividend cut in February. Released late in April, Intel reported a 36% fall in first quarter sales to $11.7 billion, stronger than guided for, although they are dismal results of course. Except for an increase in revenues within the Mobileye division, every other segment posted revenue declines between 24% and 39% on an annual basis, as an indication of the widespread weakness in its results.

Intel posted a non-GAAP loss of $0.04 per share as the guidance for the second quarter suggests that stabilization is seen. For the second quarter, sales are seen at $12 billion, plus or minus half a billion, with adjusted losses still seen at four pennies per share. Moreover, the company indicated that it expects a sequential revenue improvements by the second quarter into the second half of the year.

This is somewhat comforting from a commercial point of view, although that adjusted losses underestimate the realistic losses, as it among other excludes for stock-based compensation expenses as well as some restructuring efforts as well.

Cash flow conversion is key, as net debt ticked up quite a bit to $22.7 billion amidst continued dividends, net capital investments, and some poor working capital performance. Moreover, the piggy bank of Intel, its stake in Mobileye, has seen a small pullback as well, now trading at $38 per share, with Intel´s stake valued around $32 billion. This money is perhaps needed as the company hopes for a quick deal progress on the >$5 billion pending Tower Semiconductor (TSEM) deal.

What Now?

The reality is that I am pleased with the signs of stabilization, although Intel Corporation is still losing a bit of money here, and moreover sees huge cash outflows. This is important as the balance sheet deteriorates at a huge pace amidst losses and net capital investments, although this is offset by lower dividend commitments and hopefully some better quarters to come in the second half of the year.

Hence, I am performing a balancing act, where I like the signs of stabilization, yet recognize the balance sheet deterioration. This makes me still cautious about Intel Corporation here, certainly in the light of a swift 20% rally since the day of the dividend cut was announced. Hence, I continue to stick with a modest long position, looking to sell Intel Corporation shares on potential rips further from here.

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