Intel Corporation Lowers Long-Term Data Center Growth Forecast

By Ashraf Eassa Markets Fool.com

For many years now, microprocessor giant Intel (NASDAQ: INTC) had been telling its investors to expect its Data Center Group (DCG), which supplies components and platforms for data-center applications like cloud servers and networking appliances, to see 15% compounded annual revenue growth over the long term.

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After missing this target many times over the last several years -- as Bernstein Research's Stacy Rasgon pointed out in a recent note to clients, Intel only met or exceeded the 15% goal once in the last six years -- Intel finally took down its long-term growth target at its Feb. 9 investor meeting.

A wafer of Intel processors. Image source: Intel.

The company also told investors to expect operating-profit margin declines in this segment, too.

Let's go over the company's new financial targets, and look at the company's rationale for bringing them down.

From 15% to...

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Although Intel saw 8% revenue growth in DCG in 2016 and expects "high single-digit" growth in this business in 2017, the company's long-term revenue growth target is now "low double digits," which I take to mean "greater than or equal to 10% but less than 15%."

The reduction in this forecast, per Intel, is driven by a couple of factors. The first factor is that sales of products into enterprise servers -- roughly half of DCG's revenue today -- are expected to decline in the coming years. Intel had previously expected enterprise-server sales to grow, so a new expectation of declines here is clearly dinging the long-term growth forecast.

The second factor is that the company saw a push-out of a couple of key products, namely its 3D XPoint memory modules (which the company hoped to launch in mid-2017 with its new server platform called Purley, but now expects to contribute to revenue in 2018) as well as its silicon photonics products.

Intel is betting on a significant portion of its DCG growth to come from sales of these "non-CPU products," so push-outs of those key products clearly hurt its revenue-growth forecast.

Profit reductions, too

Intel is now forecasting that revenue growth will be faster than operating-profit growth -- which, put more bluntly, means that operating margins (how much of each revenue dollar is converted into operating profit) will come down.

A more detailed look at why the company expects operating margins to come down can be found elsewhere, but the bottom line is this: Intel now plans to move its data-center processors to its latest manufacturing technologies first. And, since the latest technologies tend to be more expensive than older technologies at first, this should increase the company's unit costs, reducing gross profit margin.

The company also expects its non-CPU products to outgrow its CPU products, and since its non-CPU products carry lower gross profit margin than do the CPU products, this should also serve to reduce gross profit margin in DCG, and therefore operating margin.

Finally, Intel says that a greater portion of the company's overall corporate expenses will be allocated toward DCG (because DCG's proportion of Intel's overall revenue is going up). This should ultimately translate into higher operating expenses.

That said, even though operating margin is expected to come down, management expects total operating profit to grow; that profit will simply be a lower percentage of revenue than it has been in the past.

Investment implications

In the near term, the revenue-growth and profit-margin reductions that Intel expects from DCG could weigh on the stock, as they were clearly unexpected by some (the operating profit expectations were probably more of a surprise, given that Intel has routinely missed its revenue-growth targets). Nevertheless, Intel seems to be making the right moves for the long term, and the growth forecast -- though lower than before -- is still pretty solid, given the current size and profitability of the business.

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Ashraf Eassa owns shares of Intel. The Motley Fool recommends Intel. The Motley Fool has a disclosure policy.