The drop in PC sales doesn't look like it is going to stabilize as much as I had hoped and Intel (INTC) has yet to make the progress into smartphones and tablets that investors would have liked. Regardless, the company has a significant advantage in manufacturing scale and intellectual property that could make it the last man standing in the industry. Shares have been largely rangebound over the last year and long-term investors need to manage their entry points. I am maintaining my call for buying the shares below $22 with a call to cover positions around $27 per share.
Rangebound and Loving It
In October of last year, I argued that the bears were in full control of the stock but that problems were largely temporary. The catalysts for 2013, most notably the release of Haswell, and the record low valuation promised an upside of up to 30% for investors at the price of $21.48 per share.
After a month of further losses along with the rest of the market, Intel started to rebound and was gaining momentum by the beginning of the second quarter. Towards the end of April, I started getting worried that sentiment was going to take the shares too high with news of a new CEO despite a still weak revenue and margin outlook. Several readers blasted me after my call for a May head-fake where the shares would go higher only to come back down sharply. Shares were trading at $22.44 at the time.
By the end of May, shares had risen to $24.28 and I partly covered my position by selling calls. After reaching 4% higher in early June, shares came down hard on, you guessed it, further weakness in the revenue and margins outlook. The stock has fallen more than 13% to a recent low of $21.90 before rebounding a bit.
Moore's Law and the Last Man Standing
It doesn't look like PCs are going to provide any meaningful support for the semiconductor industry for the foreseeable future. Despite the progress Intel has made into tablets, it doesn't appear to be enough to stem the weakness in a segment that accounts for 64% of the company's sales. June quarter revenue of $12.8 billion was down 5% from the same quarter last year and earnings of $0.39 per share were down almost 28% from the comparable quarter.
The outlook isn't that much better. Revenue is seen flat for fiscal 2013 and earnings are expected to drop 12% to $1.87 per share. Management adjusted guidance downward on the PC environment and margin weakness. In a move to protect cash flow, management guided full year capital expenditures down by one billion to $11 billion.
In all this darkness a ray of hope appears for Intel bulls and underpins the reason I think investors can start accumulating shares again.
Moore's Law, named after Intel co-founder Gordon Moore, proposes that the number of transistors on integrated circuits doubles approximately every two years. While it is not a natural law, it has been extremely accurate since Moore proposed the law in 1965 and holds an extremely important significance for Intel. As more transistors are put on a chip, the cost to make each transistor decreases.
With Moore's Law, Intel can sell chips at a progressively lower price but still maintain its margins. Moore's Law also applies to other chip companies but Intel's manufacturing scale and lead in intellectual property means that its margins are higher. Intel's operating margin of 23% leads that of Texas Instruments (TXN) by 3% and is well above the struggling Advanced Micro Devices (AMD) and its operating loss.
Moore's Law explains why Intel is also able to maintain its intellectual lead with transistor structures and materials as well. The company has maintained a lead of about three years on competitors in successive product evolutions like strained silicon, high-k metal gate and tri-gate. This will help the company establish and maintain a position in tablets and smartphones and will support the long-term stock thesis.
Basically, if PC weakness continues and the industry is unable to stabilize chip prices then Intel will be supported by its advantage in scale and IP. A rebound in the environment for semiconductors and microprocessors will benefit everyone with Intel leading the way. It's a win-win scenario for the company.
Shorter-term Upside from Silvermount
Intel announced in May that it would release the next generation of Atom architecture named Silvermount in the second half of the year. The 22nm system on chip (SoC) will offer an improvement on peak performance or a fifth of the power usage on current performance. Intel also said that it expects to refresh the product every year which should help to support revenue. The buildup to the release could offer a short-term catalyst for the shares and further support the outlook for a long-term investment.
Limit losses with a covered strategy
With a strong cash flow supporting the 4% yield and a competitive advantage over peers, Intel can be a good long-term holding if investors manage their entry points. I like the shares around their current price of $22 per share but am a little cautious. Risk averse investors like myself might want to cover half of their position by selling calls with a short-term expiration. Investors can sell the January 2014 calls with a strike of $24 for about $0.67 per share. This protects half the position against a 3% drop but still leaves the other half to run. If the shares increase past $24 by expiration, you still make 12% on the covered half when accounting for dividends.
Investors can go uncovered into the shares if the approach $20 per share as I think the downside from there is extremely limited. Competitive advantage aside, I would cover the entire position or take profits if the shares increased to $27 per share within the next year.