Intel Does Not Compute

 | Oct 09, 2012 | 1:00 PM EDT
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On Monday, Bernstein Research cut its rating on Intel (INTC) shares to a Sell. My question is: What took it so long? The stock has fallen 22% since April. But at $22.50, I don't think the stock will fall much further. I think $20 (-9%) is the lowest the stock will go. The tech value players and the yield hounds will come out of the woodwork once Intel hits a 4.5% yield.

Intel's main problem is mix shift. If you remember back to the fourth quarter of fiscal 2009, Intel set a gross margin record that quarter when the company's yield hit 64.7%. Higher average selling prices, a rebound in business and a shift to the new 32-nanometer (32nm) production process boosted Intel's margins.

But since 2010, margins have been drifting lower. For the fiscal year ending 2010, Intel reported gross margins of 66% (another record.) PC shipments hit a peak of 93 million units that year. It has been downhill since then.

By the end of fiscal 2011, margins had fallen to 62.5%. While the Street consensus is looking for Intel to end 2012 year with a 63% margin, I think margins will come in closer to flat with last year.

The challenge Intel faces is the shift away from desktop computing toward mobile. Average selling prices are declining faster, which is putting pressure on margins as the PC business deteriorates. Both Gartner and IDC Research forecast declines in PC units between 5% and 10% in the U.S. alone. (The U.S. makes up about half of the worldwide PC business.) Intel spent $300 million in research and development on Ultrabooks, which totally fell flat. The Ultrabook market was overtaken over by tablet computing. Firms are slashing Ultrabook forecasts as fast as they can. Today, most research firms are estimating 10 million to 12 million units, down from previous estimates of 20 million to 25 million unit estimates. Tablet shipments are nearing 45 million units this year. Apple's (AAPL) iPad accounts for 70% of worldwide tablet sales.

Analysts and investors are banking on the release of Windows 8 to save the day. While a new release of Windows has always been a reason to upgrade, the world has gone mobile and the upgrade urgency (especially on the desktop) has subsided. Intel's stock price certainly doesn't seem to indicate investors are banking on a huge Windows revival either.

Clearly, Intel is a great company, but the stock seems too difficult. As mobile computing takes over, Intel's good-better-best processor strategy is under attack. If Apple releases the long rumored mini iPad in the next few weeks, it will only add more pressure to Intel's gross margins as low-end processors with lower average selling prices replace desktop sales. For fiscal 2013 and 2014, Intel could face serious margin pressure. But investors can cross that bridge when they come to it. For now, Intel does not compute.

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