Extended PC Market Weakness Increases Uncertainty for Intel's Dividend

Intel on Thursday reported disappointing fourth-quarter earnings and issued guidance for the current quarter calling for $10.5 billion to $11.5 billion of revenue, far below the consensus estimate of approximately $14 billion.

Management cited additional weakness in the personal computer (PC) market, which drives around half of Intel's sales and continues unwinding from a pandemic-fueled spike in demand as remote work and school drove an influx of consumer electronics purchases.

PC manufacturers have added to Intel's challenges by depleting their chip inventory at the most significant rate management has seen in recent history.

With Intel's shipments tracking below PC consumption levels, the steep drop in revenue will pair with the company's high fixed costs to drive an uncharacteristic operating loss this quarter.

Despite these challenges, Intel declared a regular quarterly dividend of 36.5 cents per share, unchanged from the prior quarter.

While this beats a cut that some investors feared, it also marks the first time in six years that Intel has not increased its dividend in the first quarter of the year.

Intel's frozen dividend reflects the uncertain economic outlook and building financial stress the chip maker faces as it presses ahead with its capital-intensive turnaround plan, which we discussed in more detail last year.

The good news is Intel's balance sheet remains solid with cash and investments totaling around $28 billion and an A+ credit rating, albeit with a negative outlook.

The bad news is PC and server market weakness are further straining Intel's cash burn as the company makes massive investments to expand production, build new chip factories, and equip current manufacturing sites with advanced technologies to restore its competitive position.

Intel's 2022 revenue came in $13 billion short of management's initial guidance last February. But spending reductions and working capital improvements limited Intel's full-year adjusted free cash flow to negative $4 billion, not too far below the firm's negative $1 billion to $2 billion target.

The dividend costs an additional $6 billion per year, putting Intel's total cash burn at around $10 billion last year.

Management expects free cash flow to remain negative in the first half of 2023, below prior expectations for neutrality, with hopes of breaking even in the second half of the year as customer inventory reductions abate.

Assuming this forecast plays out, Intel still has a large enough pile of cash to sustain its dividend. And management once again voiced support for "maintaining a competitive dividend."

"We take a very disciplined approach to the capital allocation strategy, and we're going to remain committed to being very prudent around how we allocate capital for the owners. And we are committed to maintaining a competitive dividend." 

– CFO David Zinsner, Q422 Earnings Call

However, it's hard to place much faith in Intel's guidance given how the past year played out.

Will management stay committed to shelling out $6 billion a year to shareholders if results continue to undershoot expectations in this dynamic environment?

Will preserving liquidity take priority over rewarding income investors if the economy dips into a recession?

Challenging market conditions have made these questions harder to answer in recent months, despite Intel's strong liquidity position and insistence that its long-term investments remain on track.

Recognizing the rising amount of management discretion involved with the decision to maintain Intel's dividend, we are downgrading the company's Dividend Safety Score from Safe to Borderline Safe.

While continuation of Intel's 5% dividend yield would be nice, investors should own the stock for its potential to at least double over the next few years if management's turnaround succeeds.

By 2026, Intel expects its capital intensity to moderate and margins to rise, returning the company to its cash cow status with a well-covered dividend and potentially double-digit sales growth.

That said, Intel's track record, including missing out on the smartphone wave and losing its lead in process technology to rival TSMC for the first time in company history, doesn't inspire much confidence.

Intel will prove to have been a value trap if its investments fail to stem the market share losses it has experienced in recent years, a tough call to make in the dynamic tech sector.

Investors can better evaluate the success of Intel's turnaround investments in 2024, when the company expects to achieve process performance parity with TSMC before resuming a leadership position in 2025.

This will be far more important for the firm's future than today's noise caused by uncontrollable macro events and share losses that reflect past missteps.

From this perspective, Intel's latest disappointing news probably isn't reason to sell for investors who are playing the long game and are comfortable with the fuzzier outlook for the dividend.

We will continue monitoring Intel's turnaround and provide updates as needed.

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