I have been interested in building a position in Intel (NASDAQ:INTC)for a few months now. The company has heritage, experience and is one of the best, if not the best in the world at semiconductor manufacture. Its current low valuation in my opinion presents a once-in-a-life-time buying opportunity.
However, there are several things that are holding me back from investing. Firstly, I don't like technology companies, their prices can be highly unpredictable as they tend to be influenced more by popularity than by actual performance.
The second point is Intel's spending habits, in particular, the company's stock buybacks and dividends. I don't like stock buybacks, unless they are essential, for example; when buy backs will categorically provide the best return for investors and there is no other investment the company can make to improve investor returns -- Tobacco companies are a good example.
So, I have set to discover the answer to three points:
- Is Intel's current 4.2% dividend yield sustainable?
- How effective are the company's buybacks?
- Are buybacks the best possible use of the company's cash?
In this article I am using historical figures to evaluate Intel's potential future performance. The future is the future and currently we have no idea what will happen for certain so historic figures are the only concrete numbers anyone has to work from.
Net Operating Cash Flow
Net Investing Cash Flow
Cash Dividends Paid - Total
Repurchase of Common & Preferred Stk.
Issuance of long term debt (Reduction)
Net Financing Cash Flow
Free Cash Flow
A quick overview of Intel's cash flows for the past three years shows that the company can easily pay its dividend, buybacks however are putting the company's cash flow under pressure.
Even with Intel's current yield of 4.2% the dividend is only costing the company $4.4 billion a year, which can be easily financed.
You see, on average over the past three years, Intel has been able to spend about $7.9 billion on financing activities, (net operating cash - net investing cash). With the dividend only consuming $4.5 billion of this cash, the company has $3.4 billion of cash left over other financing activities.
However, Intel has been buying back stock in larger quantities than it can realistically sustain. The company brought back $14.3 billion of stock in 2011 and $5.1 billion during 2012, which meant that the company had to borrow cash in order to fund these buybacks - Intel issued $5.2 billion of debt to fund buybacks during 2011 and $6.1 billion during 2012.
When a company issues debt to buy back stock this sends up a large red flag.
So what about debt?
Gross Interest Expense
Interest Expense as a % of EBIT
Intel's debt is growing rapidly, it is up a compounded 538% since 2010 and is forecast to grow another 19% during 2013, taking the total growth to 662% over three years- an alarming rate.
Historically, Intel has been a highly cash generative company, at the end of 2010, Intel had a net cash balance of $19.7 billion, up 66% from the company's net cash position of $11.9 billion in 2009. This net cash position has deteriorated as the company issues more debt to finance the buying back of stock.
Furthermore, the issuance of debt has not increased the company's enterprise value, as the stagnating share price has ruled out the rise in debt.
On the other hand, the increase in debt has reduced shareholder equity as liabilities grow faster than assets. The smaller shareholder equity value has pushed up Intel's return on equity and return on asset figures making the company look significantly more efficient than it actually is. Intel's net income has fallen a compounded 4% over the past three years.
So, what effect are these buybacks having?
$US Million except per share figures
Diluted Weighted Average Shares
EPS with buyback
EPS without buyback
Overall, Intel's net income has fallen a compounded 4% during the period 2010-2012, leading to a 4% fall in EPS not including the effect of buybacks.
Taking into account the effect of buybacks, Intel's EPS have gained 6% over the same period, indicating that over three years, Intel has spent $20.6 billion to improve its EPS by only 10%, while net income has fallen.
$20.6 billion for a 10% improvement in EPS while net income has fallen...This is a staggeringly poor return on investment.
Intel actually remains highly cash generative
While Intel appears to be wasting money buying back stock, the actual underlying figures do not appear to be that terrible.
Net Change in Cash
Net Change in Cash EX. Debt issuance
Net Change in Cash EX. Stock Re-purchase
The first row of the table is Intel's net change in cash shown on the company's balance sheet; this in itself really shows nothing of any relevance. The next row shows Intel's net change in cash if the company had not issued any debt to finance its repurchase activities.
The third and final row shows Intel's change in cash if the affect of both the debt issuance and stock re-purchase operations are removed, highlighting the free cash that the company would have generated if it had not issued any debt or re-purchased any stock during the past three years.
I have shown that Intel had an initial cash balance of $19.7 billion at the end of 2010, using the net change in cash figures above, I believe that Intel would have a cash balance of approximately $29 billion at the end of 2012, if it was not buying back stock.
So, are the buybacks worth it?
I am inclined to say no.
From January 2010 to December 2012, Intel's stock moved up just under 5%. Over the same period, shareholders have received $2.3 a share in dividend income, giving a total return of 8.3% over a three-year period, or 2.8% a year. (Unfortunately, U.S. inflation was 1.6% in 2010, 3.2% in 2011 and 2.1% during 2012, which means that Intel's shareholders will only have seen a real return of 1.2% over three years!)
Intel could increase its dividend by 50%, which I believe would be completely sustainable if the company stopped repurchasing shares. In this scenario, the company would have returned $3.5 per share to shareholders through dividends over the past three years.
Now, if the company had not repurchased any shares during the past three years the current ttm EPS for 2012 would be $1.93 - If Intel continued to trade on its current P/E ratio of 10, then the company would have an implied share price of $19.34. Including the higher dividend rate of $3.5 over the past three years, the current total return in this scenario would be 9.6%.
Now these figures are by no means scientific as they discount factors such as human emotion and other factors influencing share prices but they do bring up an interesting view point.
So, in conclusion
Intel remains a highly cash generative company, with a solid free cash flow and plenty of room for the dividend. However, the company is wasting its cash flow and increasing borrowing in order to repurchase stock.
These buybacks are having no real impact and if Intel had saved its free cash the company would currently have a cash balance of $29 billion. Doubling this with borrowing would give Intel a war chest of just under $60 billion -- with which Intel could buy ARM Holdings ($18.7 billion), Corning ($19.2 billion) and for a little bit extra Dell ($24.7 billion) --a much better choice than share re-purchases that have only improved EPS, but not income.
So, Intel can sustain its dividend and maybe even double it, but the company's buybacks are not effective. It appears that Intel is wasting its cash when there are many other opportunities to improve shareholder returns.
Disclaimer: I'm writing this piece on a laptop that is powered by an Intel chip; so is my desktop and my notebook. All two of my previous laptops were powered by Intel processors and as far as I am aware my previous two PCs were as well. I have nothing against Intel, this article is not about how fantastic Intel is, it is not about whether or not it can continue to compete in the processor market. This article is about Intel's financial position, cash flows and dividend security.