Chip-maker Intel (click ticker for report: ) reported better than expected, though still weak, third quarter results Tuesday afternoon. The tech giant saw revenue fall 5% year-over-year to $13.5 billion, which was better than consensus expectations. Earnings per share fell 11% year-over-year to $0.58 per share, which was meaningfully better than the consensus estimate of $0.49 per share. Gross margins remained flat quarter-over-quarter at 63.3%, enabling the company to beat estimates and maintain profitability.
Revenue in every region except Europe was down slightly from the previous quarter. Not surprisingly, most of Intel’s weakness came in the PC Client Group, where sales tumbled 8% year-over-year to $8.6 billion, as average selling prices fell 4% and volumes fell 4%. Production remains muted as OEMs work to alleviate inventories, which will also pressure Intel in the fourth quarter—a reason why fourth quarter gross margins are expected to be 57%-58%. Still, management remains bullish on Windows 8 (click ticker for report: ) and blamed purchasing delays for the business weakness. The firm expects Microsoft’s entry into tablets, as well as ultrabooks to boost sales, but we remain skeptical about any strength in the PC business over the near term. However, the PC business is not dead, and we expect the industry to return to growth when enterprise refresh spending resumes and emerging markets such as China see economic growth accelerate.
Data Center Group revenue grew 5% year-over-year to $2.6 billion thanks to 4% higher volumes and 1% higher prices. Though competition is growing in the space, we like Intel’s position, and as with the PC Client Group, we expect results to improve when enterprise investment picks up again. We like the long-term growth potential for managing data, and we think stability in Europe and more clarity regarding implications from the US fiscal cliff will provide the necessary environment to spark business spending.
Going forward, and as we stated previously, gross margins in the fourth quarter will likely be weaker than we’ve seen in recent quarters (and much lower than the consensus expectation of 61.4%). During the quarter, the firm expects revenue to be $13.6 billion plus or minus $500 million, the midpoint slightly below the consensus estimate of $13.7 billion. And while Intel plans to idle some facilities to prevent inventory build, the company generated over $5 billion in operating cash flow during the quarter, and it returned $2.3 billion to shareholders via dividends and repurchases. We like the company’s shareholder-friendly policies.
Though many fear Intel will be left behind by the mobile revolution, we think those worries are overblown. It’s easy to forget that Intel will likely spend around $10 billion on research and development in 2012 alone, and we expect the company will become a viable competitor in the space. Fears of anti-trust regulation will likely prevent any large acquisition such as ARM Holdings (ARMH), but we remain confident in Intel’s organic development opportunities. And given Apple’s tenuous relationship with Samsung, we think the company would love to buy its chips from another supplier. If the technology is there, we think Intel could be that supplier.
We also expect the firm to continue to invest selectively in software acquisitions, as the McAfee deal appears to be yielding positive results. Software and Services sales only totaled $588 million during the third quarter (4% of net revenue), but we see impressive profit potential in the years ahead.
With an annual dividend yield above 4% and a cheap valuation, we think Intel remains attractive at current levels. The tremendous weakness we’ve seen in PCs worldwide may result in a lower industry sales rate, but we do not see PCs disappearing anytime soon. The firm looks attractive as a dividend growth investment, and we also hold the name in the portfolio of our Best Ideas Newsletter.