Intel: Now The Fun Begins

Oct. 2.13 | About: Intel Corporation (INTC)

Whenever one wishes to gauge the performance of a particular individual stock pick, one usually compares said equity to the nearest major indices. Intel (NASDAQ:INTC), while certainly not my only conviction pick, is probably the most deeply researched name within my coverage universe. Ironically, despite a bullish stance and intense research, the stock has underperformed both the Philadelphia Semiconductor Index (NASDAQ:SOXX) as well as the Nasdaq (NASDAQ:QQQ) - up 28% and 21% respectively. Intel, on the other hand, is up a mere 11.67% YTD. While certainly not the worst offender (Qualcomm (NASDAQ:QCOM) is only up 8.8% YTD and Broadcom (BRCM) is down 21.14%), such underperformance is usually very discouraging to investors.

I am sure that many of you reading this article have considered selling or have sold at least a portion of your stakes in Intel to pursue greener pastures. There's no shame in selling an underperformer, especially when a more attractive opportunity represents itself. That being said, it is my belief that as this transition year winds to a close, Intel becomes a particularly compelling opportunity that should finally "win" during 2014 (with the first signs becoming evident during the end of 2013).

1H 2013 In Review

During 1H 2013, Intel had the following puts and takes working from a revenue growth/bottom line perspective:

+ve:

  • Tablet momentum accelerated despite relatively weak product offering (~4-5% market share taken over 2 quarter)
  • Capex reduced significantly, quelling broad market fears that Intel was significantly overspending
  • New CEO chosen, vision seems good (i.e. staying focused on Intel's prime objective - sell lots of chips)

-ve:

  • Weak baseband shipments; 3G only doesn't fly in an LTE world dominated by Qualcomm
  • Weak PC demand
  • 14 nanometer startup costs (-ve for gross margins)
  • No material revenue growth in handsets
  • Flat Y/Y datacenter revenues (due to being at tail end of Sandy Bridge generation)
  • Full year revenue/margin guide down on aforementioned PC weakness
  • Haswell Ultrabooks largely absent during critical back-to-school selling season as OEMs' Ivy Bridge inventories were still sizable

As you can see, there's not really been much to drive the stock up meaningfully over the first half. However, as we march towards the October 15th FQ3 earnings report, we may get the first glimpse of an Intel that has fundamentally bottomed as positives finally begin to mount.

2H 2013 and 2014 Look Great

While the +ve/-ve enumeration above rightly supports a stagnant share price, the list for what I expect going into 2H 2013 and throughout the entirety of 2014 looks much better:

Potential Upside Drivers

  • No factory startup cost impact, which should be good for bringing full year gross margins up
  • No excess capacity charges (these impacted Q1 2013 and subsequently full year GM), which signals an additional tailwind for gross margin
  • Full year of LTE smartphone shipments (baseband/RF + apps processor drive significantly larger TAM serviced by more competitive products) - Merrifield ships in Q4 2013 and higher end Moorefield successor launches at some point in 1H 2014
  • Full year of Android + Windows tablet shipments with competitive products in both 1H 2014 (Bay Trail) and 2H 2014 (Cherry Trail - 14nm part)
  • Continued ramp of Ivy Bridge-EP products (in particular 4 socket EP and 8 socket EX parts) followed by likely 3Q ramp of Haswell-EP (this will likely lead to chip and platform ASP uplift as well as drive a significant upgrade cycle in HPC)
  • Ramp of "Avoton" (22nm microserver part) during 1H 2014 and then "Denverton" (14nm low end microserver part) and "Broadwell SoC" (14nm high end microserver part) ramps during 2H 2014 (i.e. full year of competitive microserver parts)
  • Ramp of "Haswell" and "Bay Trail-M" notebooks across wide variety of price-points intersecting with Windows XP EOL driven PC refresh cycle (also, BYT-M could drive share gains at low end of PC market against AMD (NYSE:AMD))

Potential Risks:

  • PC market decline could be worse than feared, even with Haswell refresh/Bay Trail-M, offsetting gains elsewhere
  • Intel's tablet/phone partners could fail to gain meaningful share in the market
  • Intel's next generation XMM 7260 LTE-Advanced modem could end up being late, given the firm's record with its first LTE modem, XMM 7160
  • Datacenter growth could unexpectedly slow, or one of the ARM (NASDAQ:ARMH) server players may take non-trivial share (I view this as highly unlikely, however)

So, as far as I'm concerned, there are very real tailwinds mounting turing 2014. While it's not guaranteed (is anything in life?), the odds are very good for those who choose to be long Intel throughout 2014. What I expect is that Intel will set the bar modestly higher than Street expectations on the revenue guide for full year 2014 (+5% Y/Y against consensus 3% Y/Y) and then likely "beat" estimates quarter-after-quarter in a 2011-style showing. In particular, I'm modeling ~9% Y/Y top-line growth for CY2014, based on the following assumptions:

  • PC Client Group revenues hit $34B (flat against 2012) driven by Haswell refresh and Bay Trail-M ramp, tempered by generally weak demand environment
  • Datacenter group revenue of $13.5B (+15% Y/Y from 2013 estimates, which assume 10% increase from 2012 levels)
  • Other IA (smartphones, tablets, in-vehicle infotainment, modems, etc.) - $6B
  • Software & Services revenue of $2.5B
  • "All other" (NAND) - $2B

This puts Intel at a revenue base of $58B, or 8.8% Y/Y growth. Further, I expect gross margins to be in the range of 62-64%, MG&A coming in at $18.7B (flat Y/Y), and tax rate of 25%. This suggests net income of $13.5B, and EPS of $2.7. As is plainly visible, there is quite a bit of operating leverage that Intel can exploit if it can stabilize its core PC business while driivng significant growth elsewhere. At current multiples (12.3x EPS), shares - in the scenario that I've laid out - would be worth ~$33, implying 45% upside from current levels. With a hard floor at $19, $10 of upside against just under $4 of downside looks like a pretty attractive risk/reward proposition to me.

The real risk in owning Intel shares is, to put it bluntly, opportunity cost. If the company can't make decent headway in phones/tablets, and/or if the company's PC business fails to stabilize, then the is significant risk to my estimates. However, as far as I can tell, Intel is nearly priced for the worst and the first sign that things are actually going right (which we could get as early as October 15th in the Q4 guide), the shares should move up nicely, amplified by a fairly substantial short interest for a mega-cap. After two years of eating dirt, Intel shareholders should finally begin to see real results throughout the entirety of 2014.

Disclosure: I am long INTC, BRCM, AMD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.