Raymond James analyst Hans Mosesmann this morning cut his rating on Intel shares to Underperform from Market Perform, citing concerns that the company could be headed for what he calls "a potential gross margin nightmare."
Mosesmann contends that the 62%-65% gross margins the company has enjoyed over the last three years were the exception to the rule. During that time period, he points out, Intel gained share from AMD in both PCs and servers, and benefited from the Windows 7 upgrade cycle.
"With these benefits abating, Intel has a number of new challenges in the form of commoditization of x86 (by ARM), price competition in both PC and data center markets (also ARM) and an increasing capex burden (with little to no growth)," he writes. "We believe mid 50% (and potentially low 50% over time) gross margins are an increasing reality as opposed to a downside scenario, and investors should brace for lower estimates."
The analyst contends that Intel's issues are structural in nature, as demand increasingly shift to more energy efficient ARM-based processors. "It’s not that Intel’s x86 can’t be competitive vs. ARM, it’s just that to do so it would be at the expense of margins," he writes. "With ARM-apps processor pricing at 15-20% of x86 vs. Intel on recently launched Surface platforms, we believe a gross margin baseline below 55% should not be surprising. The data center assault from ARM will be next, and that could prove even more damaging as this is the only area where Intel has posted operating profit growth in 2012."
On the possibility that Intel could become a foundry for Apple and Qualcomm, he writes that the chatter is "amusing to us given that foundries are the low-end of the semiconductor manufacturing totem-poll."
He asks rhetorically: "Does it make sense for Intel to build $10 billion shiny new fabs for foundry work?"
And he answers his own question: "We think not for 45-50% gross margins, and ask IBM how the foundry investment turned out. Intel’s fabs are not meant for the fragmented nature of foundries and truth be known, Intel is a laggard in [system on a chip] manufacturing anyway (at least today). Regardless, a formalized foundry strategy would be an acknowledgment by Intel that its model isn’t working and a negative for gross margins."
On the recent news that CEO Paul Otellini is retiring earlier than expected, he says the move is "spit-my-coffee-on-my-PC alarming."
Writes Mosesmann: "We have discussed this dynamic recently and suffice to say that in-house CEO candidates bleed more blue than Mr. Otellini himself. In our view, building bigger fabs and accelerating process nodes at a faster cadence than Moore’s Law won’t work. Hence, the prospects of an outsider getting the CEO slot at Intel is a huge undertaking as it may take years just to change the company’s corporate culture that tends to be hubristic."
The analyst cuts his 2013 estimate to $1.88 a share from $1.97; for 2014 he goes to $2.05, from $2.26. He says the cuts are "solely due to lower gross margin assumptions." He's using a gross margin of 58% for both years, but sees potential for downside.
The analyst's bottom line: "Intel is not expensive at 10.6x our revised 2013 EPS estimate, but we see few potential catalysts to support current estimates and expect consensus estimates to move lower."
INTC is down 10 cents, to $19.86.
