Shares of Intel (INTC) rallied 3% on Friday and are now up 24% on the year after Citi analysts upgraded the stock from a hold to buy citing stabilizing PC shipments. In its disappointing 2014 guidance, Intel guided to a 5% decline in PC units (presentation here). Interestingly, Citi believes this decline would translate to an 8-10% decline in consumer PC shipments compared to Citi's 7% decline forecast. On this difference of 1-3%, Citi finds Intel to be an attractive investment, a view with which I disagree.
With the PC market so large and somewhat opaque, a slightly different view of the market's decline by itself is simply not a reason to buy Intel. Moreover when it comes to predicting the market, I am more comfortable with Intel's forecast than an analyst's, given the company's constant communication with the manufacturers. Moreover, IDC just downgraded its 2013 PC forecast to down 10.1% from down 9.7% in August (report here). In the report, IDC said consumer PC shipments are down 15% year over year. In the back half of 2013, we have been witnessing increased degradation in the PC market, particularly on the consumer side.
This fact makes me hesitant to buy Intel on the thesis that the 2014 decline will be better than anticipated. In particular I would note that Intel's 5% overall decline is a marked improvement from this year's 10.1% drop with an implied improvement in the consumer sector of 5-7%. When looking at the broader trends in the industry, Intel's guidance isn't all that conservative and suggests a deceleration in the PC decline. With worsening PC sales, I would be extremely surprised if PC fell by any less than 5% in 2014. A better view of the PC market is an untenable reason to own Intel.
Moreover at current prices, Intel really isn't a cheap stock. With continued declining PC sales, revenue and operating income should both be flat in 2014. Importantly, Intel appears to be reaching a point of peak margins with operating margins at best flat in 2014. With limited margin upside from here and downside risk if PC sales are worse than expected or fail to bottom in 2015, there is chance for some pricing pressure and margin erosion, which could significantly limit EPS upside. Based on Intel's forecast, 2014 EPS will be about flat in the $1.85-$1.95 range.
At its current price, that represents a forward multiple of 13.2x for a stock with no growth in 2014. Furthermore with its over-reliance on PC, a market with no credible growth beyond 2014 either, Intel's growth prospects are not all that great. The stock certainly pays a nice 3.6% dividend, but for a no-growth stock, 13x is a pretty realistic valuation with an implied long-term growth rate of 7.7%. It is important to note that while Intel carries $19.1 billion in cash it has $13.5 billion in debt for a relatively small net cash position of $5.6 billion. For comparison, mobile chipmaker Qualcomm (QCOM) has $29.5 billion in net cash.
Qualcomm, unlike Intel, will actually grow in 2014 with EPS of at least $5.20, giving the company an ex-cash multiple of 11x. I would far rather own QCOM at 11x than Intel at 13x. If investors had to have exposure to the PC market, there is no doubt that Hewlett-Packard (HPQ) is a far better choice. While the PC market will be soft, HPQ should be able to gain share from the likes of Dell, which will soften the impact. In fact, units shipped were up 3% last quarter, against the backdrop of a 10.1% market decline, suggesting share gains are already happening. HPQ also has a far superior suite of non-PC business with printing, enterprise services and infrastructure, and slow movement into the cloud. HPQ should earn about $3.75 in 2014 for a forward multiple of 7.5x.
The Intel upgrade will prove to be a faulty one as the PC market remains weak and Intel's valuation is relatively expensive. While Intel is at 13x, QCOM is 11x and HPQ is 7.5x, both of which are far more attractive going into 2014. I would be unwilling to pay more than 13x earnings for Intel, making $25 a very full valuation. Fair value is closer to the 12x range or $23. The Citi upgrade provides Intel longs a chance to get out of Intel at a better price and rotate into cheaper tech stocks with better growth potential. Sell the Intel pop.