The share price of Intel (NASDAQ:INTC) has appreciated by 18% to $24.81 over the past 12 months. Despite the solid price performance to date, I believe the stock remains a quality buy at the current level due to the following reasons:
Intel's valuations still look very reasonable and inexpensive even after the run-up. The stock's forward P/E multiple of 13.4x is now 13% below the multiple of S&P 500 Index, which is at 15.4x (see chart below).
Although the magnitude of the P/E multiple discount is lower than the 1-year historical average of 19%, I believe the current discounted valuation remains compelling for investors given that:
- Intel's consensus long-term earnings growth estimate of 11.2% is notably above the average of 9.0% for S&P 500 companies; and
- The stock now offers double-digit dividend growth rate and a dividend yield of 3.6%, which is one of the highest yield among large-cap semiconductors and almost twice of the average for S&P 500 Index at just 1.9%.
The price downside appears to be limited from a dividend yield perspective. Despite the fact that the recent price strength has pushed down the dividend yield to be near 1-year low, the current yield level is slightly above its 5-year historical average at 3.5% (see chart below). In addition, Intel management is very committed to dividend growth. Since 2008, the dividend per share has grown by an average rate of 12%. It is expected that Intel's strong cash flow generation (e.g., the company's LTM levered free cash flow of $10.5B as at September 30, 2013 is more than twice of the LTM dividend spending of $4.5B) would enable management to continue raising dividend at a similar rate. As such, assuming a scenario that management increases the quarterly dividend by 8% from the current $0.225 to $0.243 in approximately a year from now and declining stock price leads to an increased dividend yield of 4.2% (Intel's dividend yield rarely exceeded this level in the past 5 years), this conservative case would mean a stock price of $23.14, which implies an investment loss of just -3% after incorporating the dividend income (3.6% yield) throughout the holding period. It is noted that this analysis has not even considered the impact from future share buybacks.
Aside from my view of the inexpensive valuations, I also believe the stock price would benefit from the following key developments going forward:
- The PC market appears to have stabilized. Revenue from Intel's PC Client Group has grown over the past 3 consecutive quarters. Further, Lenovo (OTCPK:LNVGY), in its recent earnings call, expects its PC business to benefit from the current corporate PC refresh cycle as Microsoft (NASDAQ:MSFT) will end its support for Windows XP in April 2014 and recovery of the Chinese PC demand in the next few quarters. Hewlett-Packard (NYSE:HPQ) also shares the similar market perspective due to the same reason. Even with such expectation, management's 2014 revenue guidance still predicts a single-digit decline in PC volumes, leaving a room for upside.
- Management has recently taken initiative to drive long-term incremental revenue growth. The company announced that it will open up its semiconductor foundry business to competitors by selling the manufacturing services that would allow competitors to fabricate their own products at the company's facility. According to a research note from JPMorgan, Intel is expected to start producing its 10nm foundry process in 2016, which should attract major customers such as Qualcomm (NASDAQ:QCOM), Broadcom (NASDAQ:BRCM), and Apple (NASDAQ:AAPL) that can benefit from the higher performance and lower transistors. The broker anticipates that the foundry business would bring in $6.3B in revenue and $0.24 in EPS by 2017 and may more than double the company revenue CAGR for 2014-2017 from its estimate of 3.2% (excluding the foundry business) to 6.7%.
In summary, I expect a further price upside for Intel shares from the current level due to its reasonable and inexpensive valuations and the positive developments mentioned above. A buy rating is therefore warranted given the stock's current risk-reward profile.
All charts are created by the author except for the consensus estimate tables, which are sourced from S&P Capital IQ, and all financial data used in the article and the charts is sourced from S&P Capital IQ unless otherwise specified.