Intel shares started moving higher today after last night’s earnings beat, but analysts aren’t overly impressed. One area of particular importance was gross margins, which is important for all tech companies, but especially for Intel because historically, its stock price has correlated with its gross margin, notes Jefferies analysts.

Intel Corporation Price Target Bumped Up Post-Earnings

Today shares of Intel moved as much as 0.7% higher to $32.26 per share.

Intel price target to $36 for gross margins

Jefferies analyst Mark Lipacis and his team maintained their Buy rating and bumped up their price target for Intel from $36 to $37 per share in a report dated Oct. 13. They noted that one reason Intel was able to beat consensus estimates by 5 cents per share was because of better than expected gross margins.

They expect the chip maker’s gross margin to move toward 70% over the next couple of years, mainly due to its leadership in manufacturing.

Intel grows margins, cash flow through manufacturing

The Jefferies team has been Buy-rated on Intel for about two years, and the reason they upgraded the stock then was because of their thesis based on the Moore Stress principle. At that time, they predicted that smaller transistors with falling prices would result in a “shake-out” among manufacturers of semiconductors. They believed Intel would then see its lead in the areas of cost and performance extend.

The analysts see four main drivers of better gross margins over the years.

Growth in data centers

The first is growth in the Data Center Group. Over the last three, five and ten years, the segment has recorded a compound annual growth rate of between 13% and 17%. Now the business runs at $16 billion annually and has an operating margin of 50% and makes up more than half of Intel’s earnings before interest and taxes.

The Jefferies team believes that this business alone has a gross margin of between 75% and 80%. They also think that the growth trends in this division are secular, and as it grows, it should pull Intel’s overall gross margins higher.

Intel extends manufacturing cycles, cuts capex

They also note that Intel upped its manufacturing cycle to two and a half years from two years for its 10 nanometer chips. They infer this same cycle for the company’s 14 nanometer chips as well. They also said that increasing the manufacturing cycle 25% boosts gross margins by improving the absorption of fixed costs. Also staying on the same manufacturing process for a longer period of time results in higher yields.

Intel also said in last night’s earnings report that its guidance for capital expenditures is now $7.3 billion, a 28% decline from last year. The Jefferies team believes this lower capital expenditure will result in a 24% increase in cash flow this year and result in lower expenses for depreciation.

And fourth, the analysts noted that Intel has had stronger average selling prices than expected, particularly in the Data Center Group and now in the PC segment. They noted that both Apple and NVidia have demonstrated this as well, so they believe customers value Intel’s “increasingly unique ability” to make transistors that are smaller, less expensive, and faster than those of its competitors.