AJ Bell press comment – 27 January 2023
- Intel predicts steep fall in Q1 sales and deeper loss
- Microprocessor giant warns of weakening end markets and rising inventories (just as chip makers pile on capacity in response to supply chain shortages)
- Silicon chip stocks and SOX index have been good guide to the economy and wider markets in the past
“UK-based investors may look at Intel’s weak fourth quarter in 2022 and stink-bomb guidance for the first quarter of 2023 and just shrug, in the view that Intel’s dreadful share price performance means this is not really news and it is nothing to do with them anyway – but they just might be wrong,” says AJ Bell investment director Russ Mould. “Stock markets are rising as they believe inflation will ease, there will only be a mild recession and interest rates will be able to gently slide lower, but Intel’s warning of weak PC demand, sagging server volumes and an inventory bulge challenges that oh-so-cosy consensus.
“It is possible to argue that some of Intel’s woes are self-inflicted, as its inability to crack the mobile market has cost it sockets at Apple, which has started to use its own silicon chips in its Mac PCs, and Advanced Micro Devices has taken market share in the wider microprocessor market at Intel’s expense.
“But Intel’s problems could be deeper even than those and leave the entire semiconductor industry on a state of red alert.
“Fourth-quarter sales fell 32% year-on-year and the chipmaker has warned of a 40% year-on-year drop in the first quarter of 2023, using the mid-point of its guidance range.
Source: Company accounts, mid-point of management guidance range for Q1 2023E
“The drop in sales, combined with the company’s substantial fixed costs (as evidenced by $80 billion in tangible fixed assets on the balance sheet, compared to $64 billion in annual revenues), will lead to a deeper net loss in the first quarter and the third trading deficit in the last four reporting periods.
Source: Company accounts, management guidance for Q1 2023E
“So far, so bad, and possibly so far, so company specific. However, Intel does flag three wider industry trends which could be of far greater concern:
- First, a decline in the PC market to the low end of the expected 270 million to 295 million units range. That compares to 286 million in 2022 and 341 million in 2021, according to Gartner. This suggests that lockdowns, stimmy cheques, furlough payments and working from home boosted demand to levels that could not be sustained, not least as demand was pulled forward.
- Second, Intel flags a year-on-year drop in demand from server clients in the first half of 2023. This ties in with Microsoft’s guidance about weaker demand in its cloud businesses. It also ties in with the theory that lockdowns and remote working prompted demand for server and cloud capacity that many suppliers assumed was the new normal, only for those growth rates to prove unsustainable.
- Third, Intel flags the need work through inventory, as it flags how sell-in has been less than sell-through. Again, this fits with the picture of a silicon chip industry surprised by strong demand in 2020 and 2021 (thanks to extra demand for laptops, headsets, smartphones, tablets and cloud-based services) which has then poured on fresh supply, only to find end demand slackening as fiscal and monetary stimulus is turned off and the economy slows.
“Intel’s own capital investment (capex) budget has soared by 70% in two years, just in time for demand to slow.
Source: Company accounts
“Capex-to-sales ratios are expected to have risen again in 2022 on an industry-wide basis as well, according to aggregated consensus analysts’ forecasts for all of the members of the 30-stock Philadelphia Semiconductor Index (also known as the SOX).
Source: Company accounts, Marketscreener, consensus analysts' forecasts
“It is this combination of increased supply and an apparent end-market slowdown that it leading to the build-up of inventory – unsold product that will have to be shifted before output levels can be ramped back up again.
“In Intel’s case, inventories rose 23% year-on-year in Q4 2022, even as sales fell. That took inventory days to 141, up from 103 a year ago.
Source: Company accounts
“This is a trend that has been in evidence across the SOX index for some time. As more fourth-quarter reports come in, the balance sheets of the SOX’s constituents could be more informative about what could happen to the semiconductor industry in 2023 than the profit and loss accounts, especially if inventories kept growing (and growing) in Q4.
Source: Company accounts
“And this stuff really matters to UK-based investors, for two reasons.
“First, the semiconductor industry generates annual revenues in excess of $600 billion and by their very ubiquity silicon chips are a good guide to economic growth, because they are found everywhere from smartphones to servers, cars to industrial robots and smart meters to laptops. If chip inventories are piling up and end-markets are slowing down, this could challenge the consensus view of a mild, shallow recession and warn of much deeper earnings forecast cuts across a range of industries.
“Second, US equities are still heavily weighted toward technology stocks, and if tech stocks stumble that could hold back the headline indices. In addition, silicon chip stocks are beloved my momentum traders and they thrive off earnings upgrades and shrink in the face of earnings downgrades, because their business models are so highly operationally geared – a 1% change in sales (up or down) will have a much bigger impact on the bottom line. Chip stocks also tend to lead headline equity indices, because they are a good gauge of both investor risk appetite and earnings forecast momentum. The SOX peaked before the wider indices hit bear market trouble in 2000 and 2007 and bottomed before their fortunes turned in 2003 and 2009.
“If the chip-laden SOX index goes cold and soggy, after its hot start to 2023, then there could be trouble ahead for stock market investors.”
Source: Refinitiv data
