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In trying to figure out the best way to play the semiconductor and microchip market, is there a better company than Intel (NASDAQ:INTC)? The chipmaker was pushed down as much as 5% last week after its most recent earnings announcement. Intel's recent earnings announcement showed earnings and revenue that beat analysts' forecasts. Both billionaires Jim Simons and Ken Fisher are two of the top fund owners of Intel as of the third quarter (check out all the hedge funds that love Intel).

The real stock pressure is coming from weak guidance. The company now expects first-quarter revenue to come out to $12.7 billion in the mid-range, which is below consensus estimates of $12.9 billion. During the fourth quarter, the chipmaker's net earnings were $0.48 per share, compared with $0.64 a share in the same quarter last year. Analysts had expected the company to report earnings of $0.45 cents a share. Intel also sold 6% fewer PC chips (its largest business) in the fourth quarter. Not only are PC sales pressuring the stock, its Ultrabook market is not growing as fast as Intel had hoped. Intel had planned on Ultrabook sales reaching 40% of all laptop sales by the end of 2012, but this failed as well (read more about Intel's earnings).

I can't say I disagree with David Klein and his valuation of Intel. Klein wrote a solid piece on Intel, What Is Wrong With Intel?, and did serious legwork, so I'm not going to rehash the margins and revenue growth. His valuation puts Intel as currently fair valued. I believe this to be true and would go as far as predicting that Intel's share price could be lower over the next two years. Even so, the real thesis of this article is whether a bet on Intel is better than a bet on one of the cheapest stocks, Nvidia (NASDAQ:NVDA), or the best growth stock, ARM Holdings (NASDAQ:ARMH), in the industry.

The pro forma earnings and dividends for Intel looks something like this:

Intel

2012

2013E

2014E

EPS

$2.13

$1.93

$2.09

Dividend

$0.90

$1.04

$1.20

Dividend Payout

42%

54%

57%

The current dividend yield on Intel shares is around 4.2%, the highest among major chip makers. Assuming it continues its 15% dividend growth rate through 2014 and multiples (price to earnings) contract over the next couple years to 8.0 times earnings, Intel would be trading at $20.90 toward the end of 2014. This would lift the dividend yield to 5.7%, and accounting for dividends, the return over the next two years would be 8.88% cumulatively.

Some of the other major semiconductor players includes Qualcomm (NASDAQ:QCOM) and Advanced Micro Devices (NYSE:AMD). All of these companies have their own fundamental issues and specific issues in their product markets, but from a valuation standpoint, they stack up as follows:

Price to Earnings (next year earnings)

Price to Operating Cash Flow

Price to Sales

Intel

10.3

5.7

2.0

Nvidia

12.7

10.4

1.8

Qualcomm

13.5

17.7

5.8

Advanced Micro Devices

--

-2.8

0.3

ARM Holdings

47.2

21.3

21.3

Although ARM is one of the most expensive companies in the industry, it offers investors the best potential growth. Leo Sun also has a solid piece on how ARM is dominating Intel, which in part explains why ARM has an expected five-year earnings growth rate of 22% compared with Intel's 9%.

Stacking Intel up against one of the fastest-growing chip makers, ARM Holdings:

AMR Holdings

2012

2013E

2014E

EPS

$0.60

$0.73

$0.90

Dividend (per share)

$0.90

$1.04

$1.20

Dividend Payout

42%

54%

57%

ARM Holdings is one of the best growth stories in the industry and currently trades at $41.43 per share. To return the same 8.8% that Intel is expected to return, ARM would need to trade at $45.11 at the end of 2014, which is 50 times earnings. That's a serious multiple when compared with other peers.

Stacking Intel up against one of the cheapest chip makers, Nvidia:

Nvidia recently announced a dividend that equates to a dividend yield of 2.4%. Assuming Nvidia can match Intel's dividend payment growth of 15%, which seems feasible given the tech company has $3.4 billion in cash and the new annual dividend payout is just under $200 million. The estimated earnings and pro forma dividend payments are as follows:

Nvidia

2012

2013E

2014E

EPS

$0.94

$0.86

$0.96

Dividend (per share)

$0.30

$0.35

$0.40

Dividend Payout

32%

41%

42%

The stock is at $12.17 and even with dividends the company would need to trade at 13 times earnings, that is a quite a premium to Intel's current price-to-earnings multiple of 10, and its assumed forward multiple of 8. At a price-to-earnings multiple on 2014 estimated EPS of 8, Nvidia investors would actually lose 30%.

Back to the topic, is Intel the best way to gain exposure to the chip market? In this case it is best to choose the dividend play, versus the growth or value one. Intel continues to be the leader in the microprocessor market, owning upward of 80% of the market share. Intel's server business should continue to perform well, with big spenders being corporate customers and data centers. The server market should be lifted by a higher demand for lower-cost computing. Also helping drive Intel and the industry over the interim should be the transition to cloud computing and virtualization. Intel's balance sheet is also nearly bullet proof with $18 billion in cash and only $13 billion in debt. Free cash flow generation is also robust, generating $16.6 billion over the trailing twelve months, compared with $10.1 billion for 2011.

Conclusion

But of course, there is the question of what happens to all these companies during a fundamental decline in the semiconductor industry? Assuming the industry remains a solid investment opportunity, the best option appears to be Intel. One slight fallacy in all this is that Intel has a robust buy back policy, which could lead to even more upside to the stock. Billionaires Ken Fisher and Jim Simons are two big-name hedge fund managers that own over 18 million shares of Intel each (check out Jim Simons top picks).

Source: Is Intel The Best Way To Play The Chip Market?