I originally thought about titling this article "YAIA: Yet Another Intel Article" but I wasn't sure there were enough graying techies like me who would get the joke. I can still remember coding up my first 8086 - how cool was that - and when the state of the art was a 20 mHz bit-slice processor. Okay, I am dating myself, but the point I want to make is that I'm not exactly up on the latest technology when it comes to computer chips. So why am I writing yet another article on Intel especially since I don't really now about the technicals? Well, its because, while I may no longer be one of the technophiles, I know an attractive investment when I see one. For more details on the technical side, I would recommend reading some other SA authors, for example, here.
First, let me state the obvious. Intel (NASDAQ:INTC) has had a rough patch and it appears little improvement will occur in the near future (i.e., Q1/2 2013). The bet with INTC, however, is that as smaller, more energy efficient chips come on line, they will make headway into the tablet space and, eventually mobile. My understanding is that they are 12-18 months ahead of the competition in terms of these new chips. They already have a presence in both tablets and mobiles but it is marginal at best. Speaking of tablets, Intel's near-term bet is on the so-called hybrid-tablet, which they term ultra-book and is basically a tablet with a keyboard. Personally, I think they are going to be successful there. Tablets are "fun" but, outside the very low price point (e-readers), I just don't find them very functional. Neither does anyone I've spoken to, nor my kids either. In fact, I joked in a comment recently that if I could find my kids' iPads, I'd find all my missing socks. I'm not kidding - they just don't use them. Also, maybe I am just old in the way, but I have serious doubts about the death of the desktop PC, particularly in emerging economies.
INTC is priced for little in the way of growth for both 2013 and, in our view, 2014. We can't blame the market for such, particularly in light of 2012's performance. As can be seen in the table below, 2012 was not something to write home about. Intel's core business (pun intended) is the Personal Computer Client Group (PCCG) group, which accounts for 64% of revenue, and was down 3% in 2012 as classic PC sales declined. While the Data Center Group (DCG), grew 6%, this cloud and server based segment could not offset PCCG's troubles. In total, revenue declined nearly 1%. This may not seem like much but with growing expenditures - both cap-ex and R&D - the impact on the bottom line was not good. For example, our adjusted(1) net income was down a eye-popping 15% in 2012. Even with the drop in share count, via buybacks, adjusted net income per share was still down 10%. We also show in the table our baseline estimates for the next few years. In line with Intel's guidance, we assume total revenue growth will be in the low single-digits for 2013, which we peg at near 3%. We assume PCCG will grow a modest 1% and pick up into 2015 as sales of traditional PCs and hybrids increase. DCG is assumed to grow 10% next year, the low end of Intel's "double-digit" guidance, and nothing for the other groups, which account for the remaining 16% of revenue.
Table 1: Intel's Segmented Revenue Growth. Actual For 2012 and Our Baseline Estimates Going Forward:
Shown below are the actual and estimated financial statistics based on our baseline revenue growth expectations and other company guidance and assumptions. We believe we have been conservative in our assumptions with, for example, depreciation and amortization ramping up as the increased capital expenditures of late begin to take root. As stated, we adjust our financials to take out what we see as potentially non-recurring, so our numbers may not agree exactly with Intel's historical reported results. Of import is that Intel's free cash flow - FCF - has been more than sufficient in the last two years to cover both cap-ex and dividends. In fact, the dividend coverage ratio, which we define as (FCF minus capex) / dividends has been well above 1.5 historical. One of the issues going forward, that may thwart investor appetite, is the increased cap-ex that is slated for 2013 that won't impact growth till later in the decade (e.g., $2bn for 450 mm wafer technology - now that's a big disc),. In addition, there is peak spending for the roll out of 14nm products and the beginning of 10nm spends. Our view is that these expenditures are necessary to get the growth of the future.
As we started off the article saying, 2013 should be another trying year. We see net income being down ~4% as increased costs (e.g., R&D as well as depreciation) mount during a slow revenue rebuild. We do expect Intel will continue to buy back shares (200mn in '13) both with excess cash as well as via recent debt issuance. This will help maintain NI/share roughly flat for the year. On the cash flow side, Intel will continue to maintain healthy coverage although, at 125%, the dividend coverage in '13 will be the lowest on record for the company. While certainly enough to maintain confidence in the company's dividend paying ability, it is clearly a factor in the stock's current financial ratios (e.g., low PE and high dividend yield). We would note that for the dividend coverage ratio to get below 1, we would need PCCG revenue to decline 3 (worst than 2012) and another significant drop in "Mobile." While a repeat of 2012 is certainly possible, we are more optimistic and, even with such, the company will have no trouble maintaining their dividend (plenty of cash). Note we assume no increase in dividends this year.
Looking beyond 2013, we see modest segment revenue growth, leading to the start of a rebound for Intel's net income, dividend growth and coverage. By 2015, assuming still conservative assumptions for PCCG, we see net income per share rebounding to 2011 levels of about $2.5 per share; 12% y-o-y growth . Assuming a terminal PE of ~12, we forecast a conservative target price of near $30/share for 2015. Applying a 15% discount rate, which is more than a 10% premium to Intel's long-term bonds(2), to the resulting cash flows presents a fair value of $23.3 for Intel's shares. Similar to before, to calibrate to today's market price of about $21, we would need to see 2013 be a repeat of 2012. While no one can predict the future, we believe much pessimism is already priced into this stock. We feel quite comfortable that the dividend will be maintained and that we are getting handsomely paid to wait for Intel's leading technology to take root in the devices of tomorrow.
(1) We adjust reported net income, and other financial items, to extract out what we believe our non-recurring and, therefore, our numbers may not agree with Intel's reported numbers.
(2) As of this writing, Intel's non-callable 2039 bonds are yielding 2.25% and the callable 2041 bonds 4.5% (higher yield due to call option).
Additional disclosure: We May Be Wrong.