Intel will hit $36 by 2016
I have been writing articles highlighting some of the segments that Intel (INTC) competes in and now I want to wrap all of that information together and estimate what kind of stock price appreciation can be expected from Intel over the next three years. ARM Holdings (ARMH) has gained approximately 56% over the last year, though I would expect that growth to slow down or reverse course if my targets for Intel are reached. Qualcomm (QCOM) stock price was basically flat last year and, again, if my targets for Intel are reached I would expect this trend to continue or start to decline. Nvidia (NVDA) saw a decline in stock price last year and I would expect that to continue or worsen as Intel becomes a bigger player in the markets it competes in. During the next several paragraphs I will outline my expectations for Intel's revenues and ultimately it's net income. I will use growth and sales estimates to show where I think the stock is going and will try to do so in a manner that will allow you to adjust those estimates based on your own due diligence. I feel this will add more value from this article's analysis and allow you to come to your own conclusions from my data. One of the first articles I wrote was, "Take Analyst Opinions With a Grain of Salt", and now I am providing an opinion. By writing this article in this manner you can take my analysis at face value or adjust my growth numbers according to your own conclusions and see what kind of stock price that would create for Intel. Then you can decide if you would like to invest or not.
Intel derives the bulk of its revenue from designing and manufacturing microprocessors and chipsets. Intel has four operating segments; PC Client Group (PCCG) for desktop, laptop, and notebook computers, Data Center Group (DCG) for servers, workstations, and storage platforms, Other Intel Architecture (OIA) for mobile communications, embedded applications, netbook, tablet, and smartphones, and Software and Services Group (SSG) which includes McAfee and Wind River Software (Intel 2012 Form 10-K).
Intel's most similar competitor is Advanced Micro Devices (AMD) a company that also designs and manufactures microprocessors. is very small compared to Intel in terms of market cap but does compete directly with Intel and does command a minor share of market in Intel's primary markets. The shift in computers to a greater focus on mobile computing has affected AMD, like it has Intel, and it is struggling to generate profits. Intel also competes with foundry companies because Intel builds chips, though most of Intel's foundry work is manufacturing its own chips. Intel has created strategic alliances to manufacture chips for its partners, Altera (ALTR), Achronix, and Cisco (CSCO), bringing it into competition with Taiwan Semiconductor (TSM) and United Microelectronics Corporation (UMC). The three companies that Intel competes with for designing chips are ARM Holdings, Qualcomm, and Nvidia. ARM Holdings licenses its chip designs while Qualcomm and Nvidia utilize Arm holding designs for creating their own chipsets. The competition with Qualcomm and Nvidia is truly over design wins for placing their chips in the products that will actually be sold to consumers, like tablets and smartphones.
Intel has a fortress balance sheet. In 2012 Intel grew its cash and cash equivalents by $3.4 billion to almost $8.5 billion while current liabilities only grew by approximately $870 million. Intel's business generates significant free cash flows which provides it the opportunity to increase either dividends or the share repurchase program. The long-term debt increased from $7.084 billion to $13.136 billion which is a significant increase. The interesting part of this increase is $5 billion of the $6.2 billion was used to repurchase stock. This means the vast majority of the long-term debt increase was a strategic financing opportunity to fund the repurchase program with debt at historically low interest rates. Intel only has $312 million in short-term debt, a current ratio above 2, and no off-balance sheet liabilities. Based on the information in the 2012 10-K form Intel is in solid financial shape. The cash flow Intel generates from its sales are enough to fund a healthy dividend, a share repurchase program, while also allowing Intel to invest in its manufacturing capabilities.
Sales Forecast by Operating Group:
I will start the sales forecast with the PC Client Group (PCCG) since this is the largest operating group for Intel at 64% of revenue in 2012. PCCG earned $34.274 billion in revenue decreasing by $1.1 billion or (3.2%) in 2012. Tablet sales most likely cannibalized PC sales in 2012 and will probably continue to do so in 2013. The International Data Corporation (IDC) is predicting a decrease of 1.3% in the PC market for 2013. IDC also expects the emerging markets to have a less than 1% increase in PC sales for 2013 and staying in single digit growth through 2017 (IDC Press Release March 4, 2013). In the press release IDC points to a lack of touch screen enabled Window 8 PC options and less than expected consumer response to ultrabooks having contributed to the decline in 2012. I believe the launch of Windows Blue, an upgrade to Windows 8, as well as the launch of Intel's new Bay Trail CPU in the latter part of 2013 will help PC sales remain flat for 2013 instead of negative growth. I also believe the merging of the tablet market with the laptop market will help to increase sales in the mature markets and when this is coupled with the emerging market single-digit forecast growth I see sales for the PCCG increasing by 1% in 2014 and 1.5% in 2015. The table below illustrates the increase in sales (in millions) from this forecast.
This is not exactly stellar growth from the PCCG but I like to stay conservative with my estimates. Some people may believe the PC is dying but I disagree. We have not gotten to the point that a tablet can replace my need for a PC but I think we are growing to the point that we could have one device that does everything for us. I just believe the portable PC with a detachable tablet will be that form factor. Between the reduction in price and increases to battery life, with nine hours expected from batteries, sales in the convertible laptop will create growth in the market. These convertible laptops utilize processors that are at the higher end of the cost spectrum which should lift revenues for Intel beyond the modest growth in the overall market. The adoption of flash memory in the ultrabook and convertible segments of the PC market serves Intel well since it sells these products and should further increase revenues. I will modestly inflate my revenue for the PCCG to $350 million for 2014 and $525 million in 2015. I believe sales of these additional items will be more than this but I am using it to hedge against my forecast being too liberal.
The sales growth in the Data Center Group is much rosier than the PCCG. In 2012, net revenue for this group increase by $612 million or 6% probably powered by the immense growth in cloud computing. Another area of interesting growth is the supercomputing segment. Intel, in a 2011 investor meeting, described this growth as doubling from a million units for 2013 to 2 million units in 2015. This is the operating group that I see the most growth potential in. In Mr. Ashraf Eassa's article, he discusses the potential growth of this operating group through the impressive upgrade of the product line and he expects high growth figures, I have included an excerpt below:
"We believe that this is an unprecedented refresh and extension of the firm's product lineup, and as a result believe that 10% should be used as a pessimistic lower bound on growth in DCG, with 15% Y/Y growth a more realistic target. We also believe that momentum will continue into 2014 as further SoCs built on the new "Atom" core, in addition to a full platform refresh of the Xeon platform to the "Haswell" microarchitecture roll out."
I tend to agree with his conclusions and will "split the difference" and utilize 12% revenue growth in this operating group for 2013, 2014, and 2015. The table below illustrates the increase in sales (in millions) from this forecast.
The Other Intel Architecture Group contains several segments; smartphones, tablets, Intelligent Systems Group, and the Intel Mobile Communications. Smartphones is finally starting to see some results as described in my article and should reach sales of $900 million in 2013. The execution of their business strategy in mobile includes the integration of LTE baseband chips to allow Intel to enter the high-end smartphone market while expanding aggressively in the low-end smartphone market. I expect Intel to achieve 10-15% of the smartphone market by 2015. This would equate to approximately 120 million units or $1.8 billion in sales. In my other article, I analyze Intel's entrance into the tablet market and how Intel will get to approximately $420 million in revenue in 2014. Garnering 15% of the market share in 2015 would net Intel approximately $700 million in revenue for tablets, which is my prediction. This is not exactly stellar revenue growth from tablets and I do believe Intel can capture more than 15% but with the slow adoption of Windows 8 I want to stay relatively conservative. The more exciting market in my mind is the intelligent systems market. I read a press release on Research and Markets: Global Intelligent Systems Market Report 2012-2016. This report highlighted TechNavio's forecast that this particular market would grow at a 16% clip through 2016. It also named the key vendors "dominating this market" as Texas Instruments (TXN), Freescale Semiconductors, Infineon Technologies, and Intel. With Intel's purchase of Infineon Technologies this gives Intel an even more dominate position in a market that is growing quickly. Between smartphones, tablets, and the intelligent systems market I believe this operating group will earn an additional $2 billion in revenue by 2015.
The Software and Services Operating Segment increased revenues by over 20% from 2011 numbers. The majority of this increase was generated by the two extra months of McAfee Software revenue leaving a small increase of approximately 2.5%. The change in the computing industry with the explosion of mobile devices and cloud computing is playing into the strengths of the Wind River Software group. News broke about the group, "introduced the Wind River Linux Carrier Grade (CG) Profile for the latest version of Wind River Linux. Formally registered for the CGL 5.0 specification with the Linux Foundation, the profile is the first delivery of Carrier Grade Linux Functionalities on top of a Yocto Project Compatible product" (Wind River). You can read the article yourself to understand the technical aspects of this new profile; however, the registration ensures the network is more reliable and resistant to attack. This profile works for highly mobile networks as well as major corporation infrastructure. Beyond this new profile news, Wind River focuses on embedded and mobile software an industry that is seeing explosive growth. At the Embedded Research and Education Summit in February of 2012 a presentation noted the growth for the embedded industry at 10% and intelligent systems market at nearly 20%. Volumes will grow exponentially as we increase the number of mobile devices connecting to the internet. McAfee announced at the RSA Conference in San Francisco that 11 new partners have joined the McAfee Security Innovation Alliance putting them, in my mind, in a strong position to grow revenues while producing superior solutions through this technology partnering program. Mobile Security Market is expected to reach $3.5 billion in 2013 and is set for substantial growth for the next five years according to the report, Global Mobile Security (mSecurity) Market 2013-2018. Coupled with the traditional security market expected to grow by 16% by marketreseach.com and McAfee is positioned for double-digit growth. It seems that with the great growth potential of Wind River and McAfee this operating segment could see revenue growth of $2 billion by the end of 2015.
Total Revenue Growth by the end of 2015 (in Millions)
The above table shows the additional revenue that I expect Intel to grow through the end of 2015. The table highlights my belief that while desktops and portable computers will always remain a large part of what Intel does, we will see software, mobile, and embedded applications making up a larger portion of the overall revenue picture. But what does all of this mean in terms of share price, which is the point of this article. I am going to assume that last year's percentages for net margin hold true for 2015. This is a simplistic approach since each operating segment carries different gross margins but since Intel is very large once we pool all of the revenues together I felt this would be accurate enough for this exercise. It is my opinion that gross margins will stabilize as growth comes back to the PCCG and the addition of the custom foundry work will limit the excess capacity charges. The SSG carries very high margins, over 70% for McAfee so the growth in that category should help margins overall. But back to the original story, $8.431 billion in new revenue at the 2012 net margin of 20.6% is $1.736 billion in earnings.
Before I produce a share price we need to look at the share repurchase program. Intel in 2012 repurchased over 190 million shares. The cheap share price of Intel, cheap interest rates for debt and the free cash flow from the company lead me to believe they will continue to repurchase shares at their current rate. If this is correct that would leave approximately 4.6 billion shares (diluted) by the end of 2015. The additional earnings would equal $.378 per share and when that is added to the 2012 EPS of $2.39 our total EPS would be $2.768. At the current Price/Earnings multiple of 10 that would mean a share price of $27.68. This P/E is very low historically and if Intel can execute on its strategy on mobile and we see gains in the other Intel architecture and software operating groups, I think the market will reward Intel with a greater multiple. The 5-year average for Intel is 16 so even if we only see a multiple expansion to 12 or 13 that would produce a share price of $33.21 - $35.98. It is my belief that when Intel starts to win market share in the mobile market we will see the P/E increase to 13 or possibly higher depending on Intel's success. If the PC market begins to expand again that will also have a positive impact on the PE multiple. I see great upside potential in Intel and a killer dividend to boot. My prediction for the end of 2015 is a share price of $36.