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Intel faces tough road meeting its own high expectations

The chip maker posts first-quarter results on Tuesday.

Mark Lennihan/Associated Press/Mark Lennihan/Associated Press

Investors will get a glimpse into the health of the personal computer sector when Intel Corp. posts first-quarter results on Tuesday.

The Street is expecting flat growth and a dip in earnings as the company scrambles to catch up in the booming smartphone and tablet sectors. The market is not giving Intel a lot of respect – and that makes the chip developer's stock tantalizingly cheap in the eyes of some contrarians.

While Intel dominates when it comes to making chips for PCs and computer servers, it has ceded the upper hand in the smartphone segment to rivals, including ARM Holdings Group and Samsung Electronics Co., the world's No. 2 chip maker.

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Demand for PCs is declining in North America and is almost flat on a global basis. Last year's floods in Thailand, which disrupted the supply of hard disk drives and hurt the production of PCs, made the picture even worse.

Analysts are hoping that the supply chain problems worked themselves out in the first quarter. Last week, investors received good news when Gartner Inc. reported that worldwide PC shipments actually rose by 1.9 per cent in the first three months of the year, topping the research firm's estimates of a 1.2 per cent decline.

The hard-disk drive shortage had "a limited impact" on PC supply during the first quarter, according to Mikako Kitagawa, principal analyst at Gartner. But the PC market remains in low gear as the industry awaits two big developments, she said.

First, Intel is expected to roll out its latest chip technology, called Ivy Bridge, this quarter. It promises lower costs, reduced power requirements and faster response times. Second, Microsoft Corp. plans to begin selling its Windows 8 operating software, considered a radical departure from previous versions, later this year.

Intel is forecasting that its revenue will rise this year by as much as 9 per cent, which would come on top of 24 per cent growth in 2011. To deliver on its plans, the company is boosting spending on chip factories by 16 per cent this year, to $12.5-billion (U.S.). That amount is in addition to the $10.1-billion Intel plans to spend on research and development this year.

Nevertheless, at least half the analysts following the Santa Clara, Calif., company question its ability to meet market expectations.

"Intel has set a lofty bar for 2012 that could prove aggressive and could keep shares range-bound in the near term," says Hans Mosesmann, an analyst with Raymond James who rates the shares "market perform."

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Part of the doubt that weighs on Intel's valuation concerns the rapidly changing nature of the semiconductor market. The game is no longer just about building the fastest processors, something the company has almost always done better than anyone else. Today's customers demand additional features, such as security and energy efficiency.

Although Intel has recently announced significant partnerships with Motorola Mobility Holdings Inc. and Lenovo Group Ltd., the chip technology from ARM will continue to dominate for some time, and the success of Intel's efforts won't be fully known until 2013 or 2014, says Mr. Mosesmann.

These kind of concerns have put a lid on Intel's stock price. The shares trade at just 11 times forecasted earnings for the year. That compares with a five-year average price-to-earnings multiple of 16, says Tristan Gerra, of Robert W. Baird & Co. The analyst has a $32 target on the stock, based on a multiple of 13 times forecasts 2012 earnings, with the discount reflecting a cautious outlook for demand this year.

Intel's relatively cheap valuation exists even after a year-to-date return of 17 per cent. If management can meet its targets on Tuesday and maintain course for the year, shrewd investors may ask themselves whether a company that in one year generates $21-billion in cash, and spends more than $18-billion on share buybacks and dividends, merits a richer valuation.

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