Seeking Alpha
Long/short equity
Profile| Send Message| ()  

Overview

Over the past few weeks, I have seen an inordinate amount of "Buy Intel" articles here on Seeking Alpha. This is no doubt due to the precipitous decline the shares have seen since August. If you check out the daily chart below, you'll notice it's one of the ugliest charts you can imagine (that is, unless you are short). Intel (INTC) looks like it might want to form a bottom around $19-$20, but we shall see. What astounds me about all the Intel bulls is that it appears they are forgetting one important point about buying Intel: the market doesn't pay for Intel earnings and shareholders' equity like it used to.

We all know that Intel is the dominant player (by far) in its industry. It generates an enormous amount of operating cash flow (~$21B in 2011), and it uses that money to fund R&D for future products to grow the business and share buybacks and dividends to boost returns of its shares. Intel is, in my opinion, one of the most shareholder focused companies in the mega cap space, and that is an overwhelming positive in my view.

Intel recently announced a $6B debt offering that it intends to use to buy back more shares of stock at these depressed levels. I applaud the move, since the company will be paying less than 2.5% interest on the bonds it plans to issue and will receive a tax shield from the interest payments, making the effective interest rate somewhat lower than even 2.5%. This move of swapping equity for debt works for Intel because it is well capitalized currently (14.71% debt financing, 85.29% equity), so it is certainly not going overboard here. In short, I really like this move from the board.

While I am not one of these people who thinks computers are a dying breed of product, I do recognize that Intel needs to innovate or become another Dell. Intel has got to find new ways to grow the business. Its history of excellent management and execution cause me to have faith it will find a way to leverage the massive amount of human capital it possesses, as well as its experience in the industry and its ability to manufacture elite products on an immense scale. I have 100% faith Intel will survive this rough patch and come out the other side but let's now take a look at why I don't want to own the shares until we see the light at the end of the tunnel.

Stock Analysis

(click images to enlarge)

We'll begin by taking a look at a few metrics for INTC. First off, it is extremely well capitalized and liquidity is terrific. Intel's got $23.014B in current assets, versus only $11.953B in current liabilities. Its long-term liabilities will obviously increase once it sells its newly announced debt, but so will assets (until the company spends the money on buying back stock). This is a case where I'm happy the board has decided to swap equity financing for debt, as outlined above, so I don't have any issues with its corporate financing.

The stock, trading at $20.16 as of this writing, is cheap. It sports a 4.5% dividend yield at this price and a forward PE of 10.39. The troubling thing is that the forward PE is actually higher than the trailing PE, reflecting negative earnings growth expectations for 2013. This is our first clue as to why Intel is so "cheap" -- people are scared Intel is a "melting ice cube" for the time being, and they want it to stop melting before they put their money to work. It takes some brave (perhaps foolhardy) investors to try and call the bottom of any stock, and Intel is suffering from that right now, in my view. Take a look at the chart below: what you see is that the market is willing to pay less and less for Intel earnings over time. If Intel was still receiving the 18-20 multiple it used to, it would be a $40+ stock. But as you can see, those days are over, and INTC shareholders need to realize that the market doesn't pay up for Intel earnings like they used to. Again, this is a big reason why Intel seems so "cheap."

INTC PE Ratio TTM data by YCharts

Intel's book value as of the most recent quarter was $49.269B, or $9.89 per share, which is just under half the value of the entire company. This also seems very cheap, until you look at the chart below.

INTC Book Value Per Share data by YCharts

You can see that Mr. Market has decided that, over time, Intel's book value isn't worth paying up for any more. The book value per share has steadily increased -- and quite rapidly at that -- since 2003, but look at the blue line; the market isn't willing to pay 4 or 5 times book for Intel any more. This is another clue as to why Intel seems so cheap but can't sustain a rally.

Conclusion

To sum it up, we have discussed a couple of reasons why Intel's stock price is struggling. A lot of it has to do with the industry it's in and the PC slowdown in general. Intel, however, is still a great innovator and will come through the other side of this transformational period. Until then, there are a few things to consider if you must own the common stock. First, earnings estimates are sinking like a stone for 2013: three months ago, analysts were forecasting $2.40 next year. Now, the forecast is for $1.94. That is an astounding downward revision, and I'm quite concerned $1.94 isn't even the bottom.

Second, the market has decided that Intel doesn't deserve a high multiple to book anymore. Based on the past couple of years, it looks like 2 times book value is where the market is comfortable. Keep this in mind when evaluating if you want to own the stock.

Third, Intel's price to earnings multiple is clearly compressed from years' past, and it is likely to stay that way (or get worse) through this rough period. Even if Intel does earn close to $2.00 next year, don't be surprised to see it trade down under $18.

There are plenty of things about Intel that are still as great as ever. Management is still a firm believer in innovating, and they invest huge sums of money every day to that end. Another confidence booster for Intel's management is their ROE of 25%. That is an astonishing return, and it proves management knows what they're doing.

The silver lining in all of this is that since management clearly believes in the company's prospects and is willing to issue debt to get back a bigger piece of it, they are now able to do it at historically cheap valuations. Of course, this does not mean that the stock cannot become even cheaper, but management seems to think a bottom is near, or they wouldn't spend the money.

Lastly, if you must buy the stock right now, the only reason I could see doing so is this chart:

INTC Dividend data by YCharts

Intel has increased its dividend many times over since the early 2000s, and I have no doubt the company will continue to increase it. If you need a steady source of 4.5% income, INTC is a great bet. Just don't expect capital appreciation any time soon.

Source: Some Clues As To Why Intel Is So Cheap