Instead of Houston we have a problem, maybe the call should be Intel Corporation (NASDAQ:INTC) we have a problem. I’ve been a fan of Intel until recently, but the company’s recent earnings look worrisome. I love stocks with growth and income, so you would think Intel’s nearly 4% yield, and 11% expected earnings growth, would be right up my alley. However, when I read their earnings report, I am left scratching my head.
Everyone knows the industry is changing
It should be no secret by now that the PC industry is changing. With Windows 8 pushing computer makers toward a more touch-screen interface, and customers choosing tablets and smartphones, Intel’s challenges have been well documented.
I’ve consistently seen articles blasting Intel Corporation (NASDAQ:INTC) for their lack of a presence in mobile devices. However, in most of those articles I’ve also read the analysts suggest that Intel will be fine because they still dominate the data center business. The theory is, Intel can leverage its earnings from the data center division, survive the slowdown in the PC industry, and pick up market share in mobile devices. On paper this theory makes sense, however it may not work out this way.
The first question Intel Corporation (NASDAQ:INTC) investors should be asking is, what will the company do about the dramatic slowdown in their PC business? The company has done an admirable job of keeping its revenue losses to a minimum, but income is a different story.
Both Intel and Advanced Micro Devices, Inc. (NYSE:AMD) rely heavily on PC sales for their revenue and earnings. Intel’s PC client group makes up 69% of revenue and 70% of income. In the last quarter, revenue was down just 6%, but income dropped over 28%. The bottom line is, a 28% decrease in income from Intel’s largest source can’t be acceptable.
Don’t worry about PCs, Intel will conquer mobile eventually
A common theme among Intel investors (myself included) is, that Intel will eventually make a push into mobile that will make their PC issues fade into the background. One of the ways the company will make this happen is by outspending everyone on research and development. This leads us to the second question that needs an answer. If Intel spends so much on R&D, why are mobile sales slipping?
Intel may outspend everyone on R&D in absolute dollars, they are not beating everyone when it comes to spending relative to their sales. In the last three months, Intel spent 20.09% of revenue on R&D. Their main competition in the mobile space, ARM Holdings plc (ADR) (NASDAQ:ARMH), spent 28.82% on R&D. Even Advanced Micro Devices, Inc. (NYSE:AMD) outperformed Intel by spending 24.97% on R&D. In fact, among their peers, the only company to underperform on R&D was Texas Instruments Incorporated (NASDAQ:TXN) with a 14.27% spend rate.
This lower percentage of spending on R&D could be part of the reason Intel’s “Other Architecture” sales were down. I understand that Intel will need time to win business in the mobile space, but a 9% decline in revenue makes me question if the company is headed in the right direction.
Where is the cash going?
One way that Intel Corporation (NASDAQ:INTC) leads their traditional competitors is in the area of gross margin. This quarter’s gross margin was 56%. By comparison, ARM Holdings plc (ADR) (NASDAQ:ARMH) gross margin was 94.47%, but this is due to the fact that ARM licenses its technology. However, Intel easily beats both Advanced Micro Devices, Inc. (NYSE:AMD)’s gross margin of 15.41% and Texas Instruments Incorporated (NASDAQ:TXN) at 48.54%.
With a high gross margin, investors have come to expect good cash flow from the king of chips. However, this leads us to the third question investors need to ask. With all of Intel’s share repurchases, why are diluted shares down a paltry 0.3% year-over-year?