Before selecting a stock, there are a number of things that you need to consider in order to ensure that you are buying the stock of a high-quality company whose shares are poised to grow in value over time. Some of these concerns include what the company does, its competitive advantages, valuation, dividend payouts and sustainability, and earnings consistency.
Another important thing that you need to consider is the financial condition of the company in question. You want to know if the company is able to continue paying its bills, and how much debt it carries. The balance sheet is one of the most effective tools that you can use to evaluate a company's financial condition. In this article, I will discuss the balance sheet of Intel (INTC), in order to get some clues as to how well this company is doing.
I will go through the balance sheet, reviewing the most important items, in order to assess Intel's financial condition. The information that I am using for this article comes from Intel's website here. Note that this article is not a comprehensive review as to whether Intel should be bought or sold, but rather, just an important piece of the puzzle when doing the proper due diligence.
This article might be a bit too basic for some and too long-winded for others, but I hope that some of you can derive benefit from it.
Cash and Cash Equivalents
The first line in the Assets column of the balance sheet is for the amount of cash and cash equivalents that the company has in its possession. Generally speaking, the more cash the better, as a company with a lot of cash can invest more in acquisitions, repurchase stock, pay down debt, and pay out dividends. Some people also value stocks according to their cash positions. Some of the larger and more mature companies tend not to carry a lot of cash on their balance sheets, as they might be more inclined to buy back stock with it, or pay out dividends.
As of Dec. 31, 2012, Intel had $18.2B in cash and short-term investments, which can be easily converted into cash. This is a lot of cash for a company that has a market cap of $101B. This means that the company is trading for less than 6 times its cash position, which can be very attractive for value-oriented investors. Over the last 12 months, Intel repurchased a net $3.0B worth of stock, and paid out $4.35B in dividends. These activities are both supported by its trailing 12-month free cash flow of $7.9B.
Before I leave this section, it should be mentioned that the stock that was repurchased during 2012 was done at an average price of $24.95, which is quite a premium when compared to the stock's current price of $20.42. Sometimes, buybacks don't create the value that they were originally intended to. Shareholders may have been better served with another dividend increase instead.
Receivables constitute money that is owed to a company for products or services that have already been provided. Of course, the risk with having a lot of receivables is that some of your customers might end up not paying. For this reason, you usually like to see net receivables making up a relatively small percentage of the company's sales.
Intel had a total of $3.83B in net receivables on its balance sheet, which represents 7.2% of its trailing 12-month sales of $53.3B. In 2011, 6.8% of its sales were booked as receivables, while that percentage was at 10.0% for fiscal 2010.
Given that receivables are only accounting for about 7% of the company's sales, and that figure is consistent with what the company reported over the two years before that, I don't see much to be alarmed about here.
Another factor that I like to look at is the current ratio. This helps to provide an idea as to whether or not the company can meet its short-term financial obligations in the event of a disruption of its operations. To calculate this ratio, you need the amount of current assets and the amount of current liabilities. Current assets are the assets of a company that are either cash or assets that can be converted into cash within the fiscal year. In addition to cash and short-term investments, some of these assets include inventory, accounts receivable, and prepaid expenses. Current liabilities are expenses that the company will have to pay within the fiscal year. These might include short-term debt and long-term debt that is maturing within the year, as well as accounts payable (money owed to suppliers and others in the normal course of business). Once you have these two figures, simply divide the amount of current assets by the amount of current liabilities to get your current ratio.
If a company's operations are disrupted due to a labor strike or a natural disaster, then the current assets will need to be used to pay for the current liabilities until the company's operations can get going again. For this reason, you generally like to see a current ratio of at least 1.0, although some like to see it as high as 1.5.
The current ratio of Intel is 2.43, which is outstanding.
Property, Plant and Equipment
Manufacturing, like any other industry, requires a certain amount of capital expenditure. Land has to be bought, factories have to be built, machinery has to be purchased, and so on. However, less may be more when it comes to outlays for property, plant and equipment, as companies that constantly have to upgrade and change its facilities to keep up with competition may be at a bit of a disadvantage. However, another way of looking at it is that large amounts of money invested in this area may present a large barrier-to-entry for competitors.
Right now, Intel has $28.0B worth of property, plant and equipment on its balance sheet. This figure is significantly above the $23.6B that the company reported one year before, and the $17.9B that it reported at the end of 2010.
While the 2012 10-K filing explained that these items included land, buildings, machinery, equipment, and construction in progress, I couldn't find where it explained why the asset totals here were so much higher than what they were in years past. The company did acknowledge that it is operating in highly competitive industries, much more so than in years past. This may be requiring the company to make more investments in this area in order to continue to compete.
Goodwill is the price paid for an acquisition that's in excess of the acquired company's book value. The problem with a lot of goodwill on the balance sheet is that if the acquisition doesn't produce the value that was originally expected, then some of that goodwill might come off of the balance sheet, which could, in turn lead to the stock going downhill. Then again, acquisitions have to be judged on a case by case basis, as good companies are rarely purchased at or below book value.
Intel has $9.71B worth of goodwill on its most recent balance sheet, which is just a tad higher than the $9.25B that it reported at the end of 2011, and well above the $4.53B that it reported at the end of 2010.
The slight increase over the year 2012 can be attributed to 15 relatively small acquisitions, totaling $638M. Of the total purchase price of these acquisitions, $451M went to goodwill. Intel's huge increase in goodwill from 2010 stems from the company's 2011 purchase of cybersecurity firm, McAfee, for $6.7B, of which $4.3B was allocated toward goodwill. Intel claims in its 10-K that the amount of goodwill that's related to this acquisition is due to synergies that will be created. Another $517M in goodwill came from 13 other acquisitions in 2011 that carried a total purchase price of $2.1B.
Overall, goodwill accounts for just over 11% of Intel's total assets of $84.4B. Usually, I don't like to see goodwill account for more than 20% of a company's total assets for the reason that I discussed above. Since Intel is well below that threshold at this time, I don't see any need to panic here.
Intangible assets that are listed on the balance sheet include items such as licensed technology, patents, brand names, copyrights, and trademarks that have been purchased from someone else. They are listed on the balance sheet at their fair market values. Internally-developed intangible assets do not go on the balance sheet in order to keep companies from artificially inflating their net worth by slapping any old fantasy valuation onto their assets. Many intangible assets like patents have finite lives, over which their values are amortized. This amortization goes as annual subtractions from assets on the balance sheet and as charges to the income statement. If the company that you are researching has intangible assets, with finite lives, that represent a very large part of its total asset base, then you need to be aware that with time, those assets are going to go away, resulting in a reduction in net worth, which may result in a reduction in share price, unless those intangible assets are replaced with other assets.
Intel currently has $6.24B worth of intangible assets on its balance sheet. Of this amount, $5.30B represents assets with finite lives that will be amortized over the next 5-10 years. These assets include developed technology, customer relationships, licensed technology and patents. The remainder of the intangible assets here are not subject to amortization and include mostly acquisition-related trade names.
The amount of intangible assets on Intel's balance sheet matches what it reported at the end of 2011, but is significantly higher than the $860M that it reported at the end of 2010. Of this $5.4B increase, $3.55B came from Intel's acquisition of McAfee, while another $1.41B came from the other 13 acquisitions that were done during 2011.
While the amortization of $5.30B worth of intangible assets over the next 5-10 years isn't necessarily a good thing for the balance sheet, I am not too concerned about it, as these assets account for just over 6% of the company's total assets.
Return on Assets
The return on assets is simply a measure of the efficiency in which management is using the company's assets. It tells you how much earnings management is generating for every dollar of assets at its disposal. For the most part, the higher, the better, although lower returns due to large asset totals can serve as effective barriers to entry for would-be competitors. The formula for calculating return on assets looks like this:
Return on Assets = (Net Income) / (Total Assets).
For Intel, the return on assets would be $11.6B in core earnings over 2012, divided by $84.4B in total assets. This gives a return on assets for the trailing twelve months of about 13.7%, which is really good, especially when considering that a huge asset base of $84.4B may serve as a good barrier-to-entry. I also calculated Intel's returns on assets over fiscal years 2011 and 2010 for comparative purposes. This can be seen in the table below.
Table 1: Returns On Assets From Intel
These returns on assets are pretty good, but we see a significant decline between 2011 and 2012. This is the result of two different things. In 2012, the asset base rose from $71.1B to $84.4B, while core earnings fell from $13.5B to $11.6B, due to a roughly $600M decline in revenues and an increase in research and development spending by $1.8B. While these numbers are still good, investors will want to keep an eye on this in future quarters.
Short-Term Debt Versus Long-Term Debt
In general, you don't want to invest in a company that has a large amount of short-term debt when compared to the company's long-term debt. If the company in question has an exorbitant amount of debt due in the coming year, then there may be questions as to whether the company is prepared to handle it.
However, Intel doesn't have much to worry about here, as it reported just $312M of short-term debt on its most recent balance sheet. And, as I discussed earlier, Intel has more than enough current assets on hand to meet this, along with other current obligations.
Long-term debt is debt that is due more than a year from now. However, an excessive amount of it can be crippling in some cases. For this reason, the less of it, the better. Companies that have sustainable competitive advantages in their fields usually don't need much debt in order to finance their operations. Their earnings are usually enough to take care of that. A company should generally be able to pay off its long-term debt with 3-4 years' worth of earnings.
Right now, Intel carries $13.1B of long-term debt, which is significantly higher than the $7.1B that it reported in 2011, and dwarfs the $2.0B in long-term debt that it reported at the end of 2010.
Table 2: Long-Term Debt At Intel
In its 10-K, Intel stated that it increased its long-term borrowing over the last couple of years in order to finance repurchases of stock and "general corporate purposes." When you compare current interest rates to the 4.3% dividend yield that the company is currently paying out, this might make some sense. By repurchasing shares, the company saves money on dividends that it has to pay, and it can write off any interest that they have to pay, for tax purposes.
Of the $13.1B in long-term debt that Intel is carrying, the earliest that any of it is due is in 2016. Only about a third of it is due within the next five years. Interest rates and maturities range from 1.35% on unsecured notes that mature in 2017 to 4.80% on unsecured notes that mature in 2041. For this reason, I don't see Intel running into any trouble here in the near future, although it must be acknowledged that the debt will eventually need to be paid.
In determining how many years' worth of earnings it will take to pay off the long-term debt, I use the average of the company's core earnings over the last 3 fiscal years. The average core earnings of Intel over this period is $12.3B. When you divide the long-term debt by the average earnings of the company, here is what we find.
Years of Earnings to Pay off LT Debt = LT Debt / Average Earnings
For Intel, here is how it looks: $13.1B / $12.3B = 1.07 years
This is fantastic for Intel, in that it can pay off its long-term debt with just over one year's worth of earnings. So, while long-term debt has skyrocketed over the last couple of years, it is still well within manageable levels.
The debt-to-equity ratio is simply the total liabilities divided by the amount of shareholder equity. The lower this number, the better. Companies with sustainable competitive advantages can finance most of their operations with their earnings power rather than by debt, giving many of them a lower debt-to-equity ratio. I usually like to see companies with this ratio below 1.0, although some raise the bar (or lower the bar if you're playing limbo) with a maximum of 0.8. Let's see how Intel stacks up here.
Debt-To-Equity Ratio = Total Liabilities / Shareholder Equity
For Intel, it looks like this: $$33.2B / $51.2B = 0.65
Intel's debt-to-equity ratio looks pretty decent. To see how this figure has changed over time, I have included it from the ends of 2011 and 2010 in the table below.
Table 3: Debt-To-Equity Ratios Of Intel
From the looks of this table, the debt-to-equity ratio of Intel has been pretty good, but it is moving higher. This is due to the huge increases in long-term debt that I discussed above. So, from a debt-to-equity standpoint, I don't see anything to be worried about at the moment, but shareholders should monitor this in the years and quarters to come.
Return On Equity
Like the return on assets, the return on equity helps to give you an idea as to how efficient management is with the assets that it has at its disposal. It is calculated by using this formula.
Return On Equity = Net Income / Shareholder Equity
Generally speaking, the higher this figure, the better. However, it can be misleading, as management can juice this figure by taking on lots of debt, reducing the equity. This is why the return on equity should be used in conjunction with other metrics when determining whether a stock makes a good investment. Also, it should be mentioned that some companies are so profitable that they don't need to retain their earnings, so they buy back stock, reducing the equity, making the return on equity higher than it really should be. Some of these companies even have negative equity on account of buybacks. However, Intel is not one of these companies.
So, the return on equity for Intel is as follows:
$11.6B / $51.2B = 22.7%
This is a pretty solid return on equity. In the table below, you can see how the return on equity has fared over 2011 and 2010 as well.
Table 4: Returns on Equity At Intel
The return on equity at Intel has been pretty decent over the past three years, although it has decreased over 2012 versus 2011. This is due to core earnings that fell by 14%, coupled with equity that increased by almost 12%.
Retained earnings are earnings that management chooses to reinvest into the company as opposed to paying it out to shareholders through dividends or buybacks. It is simply calculated as:
Retained Earnings = Net Income - Dividend Payments - Stock Buybacks
On the balance sheet, retained earnings is an accumulated number, as it adds up the retained earnings from every year. Growth in this area means that the net worth of the company is growing. You generally want to see a strong growth rate in this area, especially if you're dealing with a growth stock that doesn't pay much in dividends or buybacks. More mature companies, however, tend to have lower growth rates in this area, as they are more likely to pay out higher dividends.
Intel currently has $32.1B of retained earnings on its balance sheet, which is pretty impressive by itself. This figure is up from the $29.7B that it reported one year prior, but is below the $32.9B that it reported at the end of 2010.
Table 5: Retained Earnings At Intel
The dip that you see from 2010 to 2011 is due to the company repurchasing a whopping net $12.3B worth of stock during 2011. This compares with just $1.15B in repurchases during 2010, and $3.0B in net repurchases in 2012. In 2011, the company also increased its quarterly dividend payout from 15.8 cents per share to 21 cents per share by the end of the year, amounting to a 33% increase. According to the 10-K, Intel plans to buy back more stock in the years to come, but I don't think that it will be of the magnitude that we saw in 2011. It's nice to see that the retained earnings bounced back in 2012.
After reviewing the most recent balance sheet, it can be concluded that there is much to like about the financial condition of Intel. It has a substantial amount of cash and short-term investments that can be used for acquisitions, debt retirement, dividends, and share repurchases, in addition to a strong level of free cash flow. An excellent current ratio shows that the company can meet its short-term financial obligations, even in the event of an unlikely disruption of its operations. While Intel's long-term debt has been growing, it is still at a manageable level when compared to the company's earning power. The company has shown decent returns on assets and returns on equity, even though those figures have declined versus the year before. This will need to be monitored by shareholders, in order to make sure that management is still making good use of the assets that are at its disposal.
While this is not a comprehensive review as to whether Intel should be bought or sold, it can be said that Intel is in pretty good financial condition at this time.
To learn more about how I analyze financial statements, please visit my new website at this link. It's a new site that I created just for fun, as well as for the purpose of helping others make good financial decisions.
Thanks for reading and I look forward to your comments!