Intel (NASDAQ:INTC) just cannot seem to break out of this decade's long trading range. As The NASDAQ has been hurtling towards its all time high, and 2013 was an excellent year for the index with an almost 40% return, Intel is still fumbling about in the mid $20 range. There is very little excitement surrounding the company, mediocre growth prospects at best and a stock that seems to have lost all direction.
Investors who know the company well will understand that Intel has always been a leading edge technology developer and manufacturer. The company benefits from a massive market share in the processors and semiconductors industry. Competition has always been an issue, but honestly, since Intel has been around, no competitors have been successful at stealing any substantial market share from the company. I can see that some in the investment community are worried about future growth. It's a point which must also be taken with a grain of salt. By most respects, Intel controls the computer processor market (outside of tablets and mobile devices), and the server market. As such, Intel can only grow as fast as the computer industry itself, and the PC industry has been rather sluggish of late. If Intel had a stronger presence in the mobile device and tablet market, growth would have been much stronger.
Well, that is exactly what is about to take place. Going into 2014, Intel has firm plans to move into the tablet and mobile device markets with force. At the same time, we are seeing signs that the PC market is stabilizing. As Intel moves to make low energy consumption and lower cost chips, margins are likely to slip a bit, but growth will finally start to accelerate. Intel is due for a good year, and at the moment, the shares seem extremely undervalued. I think that the patient investors will finally start to see the share price increase in value, probably rather considerably. In this article, I will give a quick overview of the current situation in the PC market, and then show how Intel will accelerate growth by grabbing considerable share of the table and mobile device market.
Superior Products, Superior price
Intel products are consistently ranked in the top of their class. Their processors are often faster than comparable devices made by competitors, and the "Intel Inside" logo does have an impact on buying decisions. Within the computer processor industry, which is commonly described as being a duopoly, Advanced Micro Devices (NYSE:AMD) is it's closest rival. The two companies have been battling each other for years and despite price wars and persistent claims about one technology being superior to the other, the two companies seem to have formed a sort of symbiotic relationship.
A metaphorical line in the sand has been drawn to delineate the boundary between the average product offered by either company. Intel has dominated the high end market, while AMD has a firm hold on the lower priced market. Intel sacrifices market share, but gets to retain its high margins. AMD produces less sophisticated chips and sells them for far less, basically controlling the low priced device market, preventing other competitors from entering the industry.
The relationship worked perfectly for a long time, but things began to unravel after the recession of 2009. As money tight consumers started to realize that a lower priced computer would fit better into their budgeting plans while still having enough power for most of their needs, the average computer price started to fall precipitously. AMD started to sell a lot more chips and Intel was left holding the bag. Intel's margins held up relatively well, but since the company was selling fewer processors, revenue and earnings were hit.
The adoption of cloud computing is also having an impact on Intel's business as consumers realized that less processing power is necessary if they were simply operating software from the cloud rather than their own PC's and laptops. Moreover, the size of the PC market has continued to shrink as consumers move towards tablets and other mobile devices. It seemed to be almost a perfect storm of events. But it's important to make the distinction that it's not really the case that Intel did not have components which could adequately meet the needs of the device manufacturers. The problem was mostly that Intel's components were simply too expensive for the low cost device market where growth was burgeoning.
The PC market is constantly changing and Intel has been vocal of late that it is very interested in creating lower cost chips in order to appeal to all price ranges. 2014 will be the turning point when the company finally starts to sell lower cost components to compete directly with AMD in the low cost arena. Since AMD is money losing company, it will have little ability to reduce prices any further on its current line of chips. This will give Intel a chance to crack the lower end market. There are some worries about margins being negatively affected, however, Intel has stated that this will not necessarily be the case. Due to the company's large overcapacity, Intel has plans to convert some of the processors and semiconductor facilities into low cost manufacturing hubs. Even for relatively cheap components, if the company can produce a high enough volume, it will be able to drive down manufacturing costs while sustaining high margins. This is Intel's plan, and it just might work.
Intel's new CEO, Brian Krzanich comes from a manufacturing background, and was the company's COO since 2012. If anybody can reinvigorate the manufacturing side of Intel, he is the man to do it. The company never had a problem with producing exciting technology. The issue was simply manufacturing the correct mix of products for optimal growth. Krzanich has been working hard over the last months to examine exactly how the company can best use its manufacturing resources in order to drive revenue while maintaining margins.
And from a historical perspective, Intel has always enjoyed some very juicy margins. You can see how Intel has historically measured up against AMD, and Micron Technologies (NASDAQ:MU). Even if gross margins were to take a small hit in the short run, they would still be ahead of the competition by a large degree.
Mobile and Tablets
The success of the mobile and tablet market really brought Intel's troubles into the spotlight. A lot has been written about how Intel missed the ball on developing low energy consumption chips for the smartphone and tablet market. As the company focused its attention on the shrinking PC market, competitors such as Qualcomm (NASDAQ:QCOM), ARM Holdings (NASDAQ:ARMH) and AMD were able to gain huge market share. In many ways, this line of thought is correct, but simply saying that Intel missed a growing market opportunity does not fully explain the problem.
Intel has a research and development budget of $10 billion per year. It's safe to say that the company could have, and most likely did, create a wide range of chips which would have easily met the needs of the mobile market. And while it can be argued that perhaps the company did not fully appreciate the growth and size of the mobile market five years ago, there has been ample time since for Intel to realign its strategy and make a push to regain its lost share. The company only actually seems to be taking those steps right now, unfortunately, after many of the competitors have already developed a firm foothold with most OEM manufacturers.
The main the reason behind Intel's lag was the fear that margins would take a beating. Smartphones and tablets generally cost much less than PC's and laptops. The management at Intel made a conscious decision to hold back from entering the lower price market, as manufacturing low cost chips could have required a large investment with low profit margin. Manufacturing facilities would have required upgrading and if the true size of the industry did not live up to expectations, Intel would have likely faced write downs and even greater capacity misalignments. Intel waited to see if the true growth story would play out.
Competitors like AMD and Qualcomm did not hesitate the enter the lower cost tablet market because making low cost chips was already the most important part of their business model. They simply saw the market as an opportunity for them to expand sales. Intel on the other hand, saw the new market as a threat, and was reluctant to enter. For a company of Intel's size and position, I can see the reasoning behind their decision, but I would have nonetheless liked the company to develop some plan to enter the low cost market.
Trading Some Margins For Higher Sales
As it stands, Intel seems to have recognized the size of the mobile market and the popularity of lower cost chips. The company aims to use its dominance within the industry and massive manufacturing capacity to churn out lower costs chips and try to maintain high margins at the same time. Intel's new line of Bay Trail, Cherry Trail and Willow Trail processors will be targeted specifically at the tablet market, for devices ranging as low as $99. While margins will likely be impacted to some degree, the chips will help to absorb some of the excess manufacturing capacity which has been burdening the company for the last few years.
Intel is also looking to expand its contract manufacturing business in a bid to restart idle chip plants. This will reduce margins, but it will drive revenue and profits. While this is probably not an ideal plan for the long term, investors must realize that in many ways, Intel's massive size can often be a hindrance. Once manufacturing plants are created, it can be very costly to leave them idle or abandoned. While CEO Brian Krzanich is probably biased towards leading the company in the direction of increasing in house manufacturing rather than towards outsourcing chip design and licensing, his current plan does seem to have merit.
From an investor perspective, I think the majority of shareholders will see a huge benefit of using the company's facilities to their maximum potential in an attempt to wring out every bit of revenue possible. Intel has worked too hard in the past simple to maintain margins rather than to actually grow the company. If the stock price is any indication, investors simply do not want that from the company. For better or for worse, the average investor wants to see growth. Consistent, and above average top line growth. In my opinion, this has been the largest factor holding the stock back for the last decade. I would certainly welcome a few percentage point decrease in overall margins if it meant a few extra percentage points in top line growth. I would even accept a nominal decrease in earnings if it meant a comparatively large increase in revenue. I think Intel's management is coming to this same realization.
Despite what naysayers might attest, 2014 will finally be the year that Intel's stock breaks out of its decade long trading range. Investors and consumers will be glad to know that Intel, despite its tardiness, will finally be making a strong push to get its chips into lower cost devices. Management will start to sacrifice margins in order to boost top line growth. And the company will make a strong push into the mobile device and tablet market. And the best thing for shareholder might actually be that Intel has completely sandbagged expectations for 2014. It will take very little effort for the company to deliver blowout earnings in comparison to what most analysts are expecting. In many ways, Intel has been using the last year to set the stage for a spectacular stock comeback, and shareholders will be pleasantly surprised as the company starts to deliver the good news.
In June, some analysts were expecting that Intel share prices could double within 5 years. So far, almost no progress has been made on that prediction. But that doesn't mean that those analysts were wrong. Considering Intel's strong dividend and share buyback program, investors are simply being paid to wait, as the company executed its business plan. Although it can be said that investors have been doing just that, for the last decade, with little to show for it, this coming year will be very different. Led by a new CEO, with a fantastic plan to specifically reinvigorate growth, Intel will finally see its revenue climb. This will be the driving force behind a stock price resurgence that will have shareholders cheering.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.