On Friday November 22, 2013 Goldman Sachs reiterated a Sell rating on Intel (INTC) with a price target of $16.00. Goldman's Senior Analyst James Covello believes even projections for flat revenue growth are aggressive.
"We attended Intel's analyst day in Santa Clara, Ca. We came into the meeting looking for reasons to get more bullish on the stock and had explicitly laid out several things we were hoping to hear during the meeting. Instead, we got nearly exactly the opposite with Intel guiding for another year of no revenue or EPS growth but still record capex levels," said Covello.
Hearing this news I thought it would be interesting to put Intel through my stringent free cash flow test and see if Mr. Covello is correct in his analysis.
This analysis will use the following six free cash flow ratios:
- Price to Mycroft Free Cash Flow
- Mycroft/Michaelis Growth Rate
- Free Cash Flow Payout Ratio
- Free Cash Flow Reinvestment Rate
Those new to this analysis can find an introduction by going here that will explain in detail how each of these ratios is calculated. When used together, these unique ratios will generate a quantitative picture of a company's underlying fundamentals, including strengths and weaknesses.
The "2014 Mycroft Free Cash Flow Per Share" estimate in the table above is generated by taking the trailing twelve months (TTM) free cash flow result for Intel and then adding my Mycroft Michaelis Growth Rate into the equation in order to generate forward looking estimates for 2014. That growth rate is generated by using my FROIC ratio (Free Cash Flow Return on Invested Capital). Basically FROIC tells us how efficient operations are as it zeros in on how much free cash flow is generated for every $1 of total capital employed. Intel has a FROIC of 16%, which means that for every $100 of invested capital, they generate $16 in free cash flow. Now my Mycroft/Michaelis Ratio takes that 16% and multiplies it by the firm's free cash flow reinvestment rate. The reinvestment rate that I use is a free cash flow reinvestment rate instead of the standard one used by analysts that simply uses net income:
Free Cash Flow Reinvestment Rate = 100% - (Free Cash Flow Payout Ratio).
Free Cash Flow Reinvestment Rate = 100% - (Total Dividend/Total Free Cash Flow).
By replacing net income in the payout and reinvestment ratios with free cash flow, I am thus able to make my analysis more precise by incorporating capital spending (Cap Ex) into the equation.
Therefore from this we can determine that Intel has a reinvestment rate of 55% and went on to use 45% of its free cash flow to pay out its dividend. Thus by taking 16% (FROIC) x 55% = 8.8% (rounded off at 9%). From there we add the dividend yield of 3.8% (rounded off at 4%) and we have a Mycroft/Michaelis growth rate of 9% + 4% = 13%.
Intel's Mycroft Free Cash Flow per share of $2.26 was generated by taking its TTM free cash flow per share and multiplying it by (100% + 13% or 1.13). Once we have our result, we then take its current market price of $23.87 and divide it by $2.26 and get a Price to Mycroft Free Cash Flow result of 10.56. I consider a Price to Mycroft Free Cash Flow per share result of less than 15 to be good for purchase, and anything under 7.5 to be excellent.
The higher you go above 15, the more overvalued a company becomes. I use a Price to Mycroft Free Cash Flow per share result of 22.5 as my sell price, and 45 as my short price.
An appropriately priced stock should trade around a Price to Mycroft Free Cash Flow per share result of 15. This benchmark result was determined by backtesting.
Buy (opinion) = A Price to Mycroft Free Cash Flow per share result of less than 7.5 is considered excellent (50% below the initial Hold level), and anything under 15 is attractive.
The result I give as my Buy opinion in the table above uses a Price to Mycroft Free Cash Flow per share result of 7.5.
Hold (opinion) = 15 to 22.5 (I use 15 in the table).
Sell (opinion) = 22.5 or higher (50% above the initial Hold level). (I use 22.5 in the table).
Short (opinion) = 45 or greater. The Price to Mycroft Free Cash Flow per share result of 45 was determined by going back to the peak of the market (in the year 2000) and averaging the Price to Free Cash Flow per share results for the key players at that time. (I use 45 in the table).
Therefore in the table above you will see that Intel, with a Price to Mycroft Free Cash Flow number of 10.56 is very attractive right now. But as Mr. Covello points out, Intel's problem is that it is spending way too much in capital spending (Cap Ex). I will outline the direct negative effect of that capex spending in the analysis below.
The CapFlow ratio result that you see in our first table above is an original ratio I created in order to tell me how much Capital Spending is used as a percentage of Cash Flow. A result of less than 33% is considered ideal and with Intel coming in at 55%, means that only 45% of the company's cash flow is actually free cash flow and can be used to buy back stock, which I am a big fan of.
In conclusion Intel is clearly a "very patient long term value investor's" type of stock at the moment as Management's projection of flat revenue growth for all of next year will clearly force growth investors out. My fellow Seeking Alpha contributor and Intel Bull Ashraf Eassastates in his recent article on Intel the following:
"I am not blind to the fact that Intel's guidance for 2014 was incredibly poor, and I am not blind to the fact that the opportunity cost to owning shares in this raging bull market is incredibly high. Believe me, as somebody with roughly 30% of his portfolio in this stock, I am seeing firsthand the dilutive effect it has had on the performance of the other 70% of my portfolio.
Starting 2014 Off With A Whimper
So, I'm going to tell it to you straight: I think Intel, at least for the next three months, is dead money."
Thus when even a very prolific Intel Bull is disgruntled about the stock, we very well could see the stock hit my buy price opinion of $16.95 that is listed in the second table above, when everything is said and done. When you add in a Goldman Sachs analyst downgrade of the stock to a Sell rating, which alone carries a lot of weight on Wall Street, then Intel's share price may be in for a drop. I believe that the smart move in the end is to wait for better news before trying to catch what could be seen as a very possible falling knife scenario. The stock itself is not overvalued according to my research (as demonstrated above), but with Management continuing to push a capital spending agenda that according to my research is some 18% more than what my CapFlow ratio says it should be (if you take Intel's CapFlow number from the first table above of 51% and minus my ideal CapFlow of 33%), they are not making it easy on themselves.