Intel: Growth Has Been Formidable

I have recapped the history of some key performance measures for INTC.

The Estimated Free Cash Flow is simply the Diluted EPS (Excluding Items) Plus Depreciation Less Capex. The EPS is the diluted number excluding items. The dividend per share needs no further explanation. The annual average price is the average daily closing price for each year.

The six year average EPS is an attempt to smooth earnings over an economic cycle; during this period we have had the Asian Contagion of 1997, the IT bubble and now the bursting of the US property and debt bubbles. With these cyclical forces at work, it is senseless to look at the long term potential of a business based on a single quarter or year. The P/E measure is a traditional P/E (Price/EPS); except that it is calculated on the annual average price. The P/E 6 measure is the annual average price divided by the six year average EPS.

In terms of growth, INTC performance has been formidable; Estimated Free Cash Flow has grown at over 10% annualized while EPS has grown at near 7% annualized. This compares with GDP growth during this period of 4.5% (2% real growth plus 2.5% inflation) during the same period. Part of INTC’s success is based on the quality of management; part of it is based on the simple fact that the IT industry underwent a revolution during this period; part of it is based on the simple fact that the US GDP growth is no longer relevant because substantial growth comes from global trading partners.

Going ahead can we expect more of the same? The management quality is still excellent; IT continues to revolutionize the way we live and work. However, with the financial crisis, we can expect some slow-down in long term growth expectations in the US and OECD Countries with perhaps a slower degree of slowdown in the emerging markets in the near future.

In the data, I have presented a long term growth expectation of 7% made up of 3% real global GDP growth and 4% global inflation. I believe these rates to be achievable and conservative. Valuing the FCF in perpetuity [(FCF*1.07)/(11%-7%)] at a target long term annualized rate of return of 11%, gives a value of near $22. Valuing EPS on the same basis gives a value of near $25. Going with Gordon’s Growth Model, which values dividend on the same basis, we get a value of near $15. The problem with all three is that 2008 numbers are used; why not use 2009 numbers instead?

Using 2009 numbers we get values of $13.37, $14.71 and $14.98 respectively. We could now argue that 2009 numbers are estimates only; besides, they might not reflect a reasonable starting point for the exercise of valuation. Why not use the six year cycle averages and use the averages expected to prevail at end 2009? Using the six year average EPS expected at end 2009 of $1.01, we arrive at a value of $27; a very similar number results if we use six year average free cash flow. For dividends, since we do not see the same volatility as earnings and cash flow, using a six year average is not appropriate.

I have also presented multiple based valuations. I have used the six year cycle EPS, multiplied by the median six year P/E to arrive at $23.46 as a reasonable price target. In order to eliminate the impact of the ridiculous valuations of the bubble years, I have also come up with a target price of $22.58 using six year cycle EPS, multiplied by the bottom quartile six year P/E.

In my view $15 is a good entry point for an investor in perpetuity. For a person with a shorter holding period, an exit target of $25 over 12 months is not unrealistic.

Disclosure: Long INTC

Comments

[Jon Smirl:]

If ARM based netbooks are successful it will be a disaster for Intel and Microsoft. The lure of sub-$300 notebooks is a strong one. Google holds the keys with ChromeOS which also runs on ARM chips.

Note that ARM chips power most cell phones. Which design is a better platform for the netbook? Trying to shrink Wintel or growing the very power efficient cell phone larger? Both can be done but my money is on the ARM CPU.

Intel may lose in both cases. They lose if ARM wins. They also lose if ARM causes the margins on their CPU chips to fall to zero. We won't know the outcome of the netbook war for another five years.

Jul 14 01:56 PM

[khaz:]

Jon,

Do you believe netbooks will ever be anything more than a niche consumer product? If not, and netbooks replace most consumer notebooks going forward, how is Intel's first mover status with Atom and current/future UPMC efforts likely to produce a 'disaster' in the netbook market?

The presence of ARM chips in cell phones does not make them the de facto superior design for netbooks, which are capable of doing a lot more than a cell phone and have a larger form factor that has been growing, not shrinking.

Long Intel

Jul 15 10:54 AM

[khaz:]

Correction UPMC should be UMPC or ultra mobile PC ... apologies.

Jul 15 10:57 AM

[Shiv Kapoor:]

Khaz/Jon - I do not think it really matters. Even is netbooks are the future INTC has the management, the innovation and the financial strength to be the leader (even if it is not the front runner). A company dies once its management and innovation dies (recent e.g. GM); INTC is far from dying. And companies even reincarnate; AAPL did, GM might!


On Jul 15 10:54 AM khaz wrote:

> Jon,
>
> Do you believe netbooks will ever be anything more than a niche consumer
> product? If not, and netbooks replace most consumer notebooks going
> forward, how is Intel's first mover status with Atom and current/future
> UPMC efforts likely to produce a 'disaster' in the netbook market?
>
>
> The presence of ARM chips in cell phones does not make them the de
> facto superior design for netbooks, which are capable of doing a
> lot more than a cell phone and have a larger form factor that has
> been growing, not shrinking.
>
> Long Intel

Jul 15 01:22 PM

[amdman:]

Intels sales growth over the past decade has been 0%, despite a growing economy, so claiming 7% growth for Intel is crazy.
Intel spent tens of billions buying back stock at $25, now we sit at $15. Squandered the money they made in the bubble years.
All of this is speculation is based off of dividend growth, but Intel is currently spending 100% of its cash flow to pay that dividend.
I do not doubt that the Wall Street crooks might run this stock up to $22, but its just as likely that Intel will be the next Tech Crash $3 company. Knowing Wall Street both these things will happen.

Jul 15 02:43 PM

[khaz:]

Intel printed $18 today. You have to go back to May to 'sit' at $15.

On Jul 15 02:43 PM amdman wrote:

> Intel spent tens of billions buying back stock at $25, now we sit
> at $15.

Jul 15 04:05 PM

[Shiv Kapoor:]

You are correct on the last ten years. Early in the century EPS/Sales were elevated due to event specific events Y2K. After that event growth returned to its normal trajectory. Going ahead, INTC will face normal cyclical challenges and I believe that while EPS will be volatile with high demand in some years with low demand in others, they will achieve 7% earnings growth with ease.


On Jul 15 02:43 PM amdman wrote:

> Intels sales growth over the past decade has been 0%, despite a growing
> economy, so claiming 7% growth for Intel is crazy.
> Intel spent tens of billions buying back stock at $25, now we sit
> at $15. Squandered the money they made in the bubble years.
> All of this is speculation is based off of dividend growth, but Intel
> is currently spending 100% of its cash flow to pay that dividend.
>
> I do not doubt that the Wall Street crooks might run this stock up
> to $22, but its just as likely that Intel will be the next Tech Crash
> $3 company. Knowing Wall Street both these things will happen.

Jul 15 10:12 PM