Why Intel Will Continue To Succeed

Feb.11.13 | About: Intel Corporation (INTC)

When the average consumer thinks of Intel, they likely think of those catchy commercials in which a popular personal computer or laptop boasts to be "powered by Intel."

Intel's Plan

To the chagrin of many, fewer PCs are being sold, and the trend will certainly continue as smartphones and tablets prove to be an adequate, cheaper and smaller replacement to bulky computers. So what becomes of Intel Corp. (NASDAQ:INTC), the world's largest computer chip manufacturer?

What you may not know is that Intel has long recognized this trend and has focused increasing resources the last few years into establishing its chips and microprocessors in the growing mobile industry. In fact, the company has recently decided to rebrand its entire mobile segment by giving it the highly successful logo of 'Intel Inside,' as it has for years with its PC customers.

Technology companies are graded heavily on their investment in research and development and the return they get on that investment. From 2004 to 2010, Intel spent between $4 billion and $6 billion annually on R&D. In the last two years, that investment has nearly doubled as the company looks to catch up to competitors like ARM Holdings and Qualcomm Inc., who have established themselves in mobile devices.

Compare Intel's 2012 R&D investment of $9.8 billion with Qualcomm's (NASDAQ:QCOM) $4.14 and ARM's (ADR) $257 million, and it's one reason why Intel's fans like its chances to succeed in the mobile market.

What did that research buy? The company announced the following new products, coming to smartphones, tablets and ultrabook computers near you in the near future:

• The Intel® Atom™ processor-based platform aimed at the value segment of the smartphone market.

• A wide range of Intel-based tablets running Windows 8 now available on shelves and online.

• A lower-power Intel® Core™ processor lineup reaches as low as 7 watts, enabling thinner, lighter, touch-based Ultrabook convertibles, detachables and tablets.

• A 4th generation Intel® Core™ processor family (formerly codenamed "Haswell") that will enable a broad new range of Ultrabook convertibles, detachables and tablets with all-day battery life; the biggest battery life gain over a previous generation in the company's history.

While there is no guarantee these products will have the same impact as Intel's PC chips did on that industry, it's tough to bet against a company with its reputation for success and one that spent so heavily to bring these new chips to market.

The emphasis on the low-end smartphone market seems to be a prudent decision. While it has lower margins, shipments for low-end smartphones are expected to increase 51% in the next three years, compared with a 26% growth rate for the high-end market, according to IHS Inc., an insights and analytics firm.

Until those new products positively impact the bottom line, some investors and analysts will be skeptical of Intel stock, which has been trading steadily for the last year between $19 and $29 a share.

Recent Performance

In its fourth quarter and annual financial report, Intel reported revenue of $53.3 billion, down 1.2% from the year before, while net income fell year-over-year by 15% to $11 billion.

Intel's first quarter and full year 2013 guidance disappointed Wall Street, coming in lower than consensus. For the first quarter, Intel expects to generate revenue of $12.7 billion, plus or minus $500 million. Gross margin is expected to be 58%, plus or minus a few hundred basis points. For the full year, Intel expects a low single-digit percentage increase in revenue. Gross margins are expected to be around 60%.

While analysts may not like the guidance provided by the company or its perceived late arrival in mobile chips, its fundamentals are strong compared with the industry. Intel is an example of a company that performs better on key financial ratios than its competitors, yet is valued less than the industry average.

Compared with the industry, Intel's recent 12 month trailing price to earnings ratio is 9.9, compared with an industry average of 14.8. Yet for a lower valued company, here's what an Intel investor receives as a premium in financial performance:

• A higher dividend yield than the industry: 4.2% to 3.3%

• A higher five-year average dividend growth rate: 12.94% to 6.1%

• A higher five-year average earnings per share growth rate: 18.87% to 13.54%

• A better trailing 12-month gross margin: 76.4% to 56.9%

• A better five-year average gross margin: 70.6% to 59%

• A much higher trailing 12-month net profit margin: 20.6% to 0.12%

• A much higher five-year average net profit margin: 20.2% to 10.4%

• A better return on assets for the trailing 12 months and five-year average: 16% to 9.2% and 14% to 7.6%, respectively.

• And a better return on investment for the trailing 12 months and five-year average: 21.1% to 13.2% and 17.5% to 10.5%, respectively.

Compare the current market capitalizations of Intel, Qualcomm and ARM Holdings. Qualcomm has a market cap of $115 billion, higher than Intel's $104 billion, yet produced nearly half the net income of Intel in 2012 ($6.6 billion to $11 billion). ARM is valued at around $20 billion while producing $239 million in net income last year. So despite generating just 2% of the profits as Intel, the market has given ARM a value equal to 20% of Intel's value.

Also consider that Intel has boosted its cash supply from $5 billion at the end of 2011 to nearly $8.5 billion at the close of last year. Qualcomm had less than $4 billion at the end of its fiscal year in September 2012.

The Takeaway

Think of it like having to share a limited amount of food with a large family. You may get to the dinner table first, but unless you consume your share of food before your bigger, older brothers sit down, you're going to have to settle for less -- assuming you get anything at all.

In this scenario, Intel is the older, bigger brother. It has more assets and resources in which to eventually compete in the mobile market, even if others got there first. It likely won't be long before the bulk of the tablet and smartphone industry is "powered by Intel."

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: This article was written by an analyst at Catalyst Investments.