Intel Corp. (NGS: INTC). Intel’s focus business in the data center, however, surprised to the downside, with revenues declining in high single digits and margins tightening. Guidance indicates that 4Q20 comparisons will be weak compared with 4Q19. 

Intel exceeded its cautious expectations for 3Q20, though just slightly; 3Q is normally the company’s strongest quarter. In the PC space, Intel showed strong unit volume growth in notebooks both annually and sequentially; but in notebooks and desktops, unit ASPs were down meaningfully quarter-over-quarter. Intel is pricing fiercely to fend off aggressive competition from AMD. Data center ASPs came down even more sharply as competition from AMD and from ARM-based solutions intensifies. 

Intel has announced the sales of most of its memory business, after announcing the sale of its mobile phone baseband business last year. The company appears to be doubling down on its processing business, which increases urgency to get it right – particularly the data center group. In July, the INTC shares were rocked by a delay in Intel’s development roadmap. The company can ill afford another push-out in its production timeline. 

The stock as of 10/23/20 was below our upgrade price and classified as one of the best stocks to buy.

RECENT DEVELOPMENTS 

For 3Q20, Data-centric revenue, meaning most of the company excluding Client Compute Group, was $8.57 billion, down 11% annually and 17% sequentially. Data-centric revenue declined to 46% of total company revenue in 3Q20, after representing a highest-ever 52% of total in 2Q20.

Overall DCG ASPs were down a surprising 14% sequentially; that likely helped limit the sequential unit decline in DCG to 3%. 

Also within Data-centric revenue, Internet of Things (IoT) revenue of $911 million fell 26% annually, as spending on factory automation and autonomous vehicle (Mobileye) remained weak amid the ongoing pandemic. This business did recover sequentially from collapse levels in 2Q20. 

Programmable Solutions revenue fell 19%. The former Altera business also saw operating profit decline 56%. 

Non-volatile memory revenue declined 11%. Intel has announced an agreement to sell most of its NVM business to Korea’s SK Hynix for $9 billion; the sale includes a memory fab.

Intel is retaining rights to the Optane Memory business that it formerly operated in partnership with Micron and that is produced in a Micron fab. 

Although Intel has deemphasized PCs, Client group saved Intel’s bacon in the quarter, as it has done many times before. 

CCG notebook volumes were up 19% sequentially, and Desktop volumes were up 10% sequentially in the holiday build quarter. Intel fought fiercely in CCG to defend share, as Notebook and desktop ASPs both declined 5%-10% sequentially.

Intel should be benefiting from explosive growth in data traffic and edge device demand as the pandemic accelerates the transition to a digital economy. Yet the company is facing some of its most severe challenges ever as it contends with newly aggressive rivals amid competitive openings created by its own stumbles. The company is pricing aggressively to preserve its market share, which is leading to gross margin and operating margin contraction. We believe Intel can ride out temporary margin pressures, but cannot afford to lose its market-share leadership. 

Intel created at least some of the competitive opening by repeatedly pushing out its production roadmap for 10 nm processors and future products at even smaller circuit widths. CEO Bob Swan sought to reassure investors that Intel is getting back on track with key products for this holiday season and more importantly for 2021. 

In 3Q20, Intel launched its 11th generation Intel Core processors, codename Tiger Lake. Designed for thin notebooks, Tiger Lake delivers faster gaming & streaming, increased office productivity, and – with Iris XE graphics – much faster content creation. Intel expects its OEM partners to have over 100 Tiger Lake-equipped notebooks in production by year-end 2020, double its forecast issued in April. 

Core is Intel’s Master Brand, and now the company has a new brand platform called Evo. Also based on Tiger Lake, Evo offers premium connectivity, audio and video, along with instant wake, fast charging, and extended battery life. OEMs are expected to offer 40 Evo designs by year-end. 

While Intel gets much of its cash flow in the PC business, the company has identified Data Center as is growth engine for the future. In PCs, Intel competes against Ryzen-based x86 CPUs from AMD, and also ARM-based Chromebooks.

Already stiff data center competition is only getting more intense. In Data Center, the competitive threat to Intel’s Xeon-based architecture is more diffuse. Rival product and strategies include x86-based EPYC chips from AMD; multiple ARM-based server architectures from companies as diverse as Marvell and Qualcomm; and GPU and TPU designs for AI learning and inference from NVidia, Google and others.

Investors view Intel’s execution in DCG as vital and as the linchpin of investing in the stock. Intel is excited about the launch of its third-generation Xeon scalable product, code-named Ice Lake; according to the CEO, Ice Lake is targeted for customer qualification in 4Q20 and volume ramp in 1Q21. 

While CPUs are ‘foundational to our business,’ according to the CEO, Intel is responding to evolving customer needs by adding a range of other processing engines, called XPUs, to its portfolio. The company is enhancing its graphics capabilities, with its Xe high-performance architecture aimed at competitive gamers. For demanding workloads in the data center, Intel is developing purpose-built GPUs partly based around the inference business acquired with Habana Labs in 2019.

For 4Q20, Intel’s guidance is consistent with low-double-digit revenue decline, continued operating margin pressure, and a 25%-plus EPS decline. 

We expect Intel to continue to price aggressively to protect its sockets with major PC and server producers in the U.S. and abroad. We also believe Intel is taking the proper steps by exiting businesses, including memory and mobile device basebands, where it has been a second-tier player. 

The latest sell-off has pushed INTC back into valuation territory relative to peers, compared with its own historical trends, and on discounting of still-strong free cash flows. 

EARNINGS & GROWTH ANALYSIS 

Revenue was above management’s 3Q20 guidance of $18.2 billion and the Street estimate of $18.22 billion.

Non-GAAP EPS of $1.11 per diluted share for 3Q20 was down 21% year-over-year and declined $0.12 sequentially; non-GAAP profits edged past guidance of $1.10 and the consensus forecast of $1.10.