Is Intel A Good Bet In The Long Run?

Jul.21.14 | About: Intel Corporation (INTC)

Summary

After reporting lousy results for the past two years Intel finally reported some impressive results.

Although the PC unit is reporting promising results, the long-term growth potential still remains a concern.

The mobile unit remains a major drag on the company’s earnings and the management really needs to focus on this potential area of growth.

Intel Incorporation (NASDAQ:INTC), the world's biggest chipmaker, after reporting lousy results for the past two years has finally reported some impressive results. The company's improving margins are primarily driven by the improving condition of the PC processor market as the company boasts more than 80% market share for desktop chips and an 87% share for laptop chips. While the company's processor segment is improving, the mobile segment is still alarming.

Impressive Results

The Santa Clara, California based company reported $13.8 billion revenues slightly beating consensus estimates of $13.69 billion. The company's improved revenues were primarily driven by the record number of quarterly microprocessor unit shipments. The company's reported net income of $2.8 billion (or $0.52 per share) grew by approx. 40% year-over-year.

The earnings beat didn't come as a big surprise to the market, as the company in its press release in June raised its revenue and earnings guidance citing stronger than expected demand for business PCs. Intel's earnings depend largely on the PC market performance as it boasts the largest share in the PC processor market.

The company's earnings beat was interesting given the fact that the tech heavy NASDAQ fell nearly 1.4% during last week as compared to the broader DJI index which only fell by 0.7%, which shows that the tech sector hasn't been performing well compared to other sectors.

PC In the Driving Seat

I think the company should continue to report impressive results for the rest of the year, driven by growth in PC sales. After a two year slump, sales of PCs are rebounding. However, I am concerned about the long term growth trajectory of the PC market. While the underlying PC trends have stabilized for now and Windows XP refresh is still a big part of the tailwind, the sustainability of the corporate strength beyond this year is still a concern.

The corporate PC business showed a 12% sequential and 9% year-over-year unit growth; however, the consumer is still weak. The global PC demand fell in the past few years because of the growing demand for tablets and mobiles and the worsening economic conditions which fueled the decline. However, the slump is now easing, driven by the growing sales in the developed markets and interest in lower priced PC models.

According to the research firm IDC, the global PC sales decline of 1.7% in the 2Q14 is the smallest quarterly drop reported in two years. The decline in the unit sales coming from the emerging market of Asia was offset by the rising demand from U.S., Europe and Canada. Otherwise a decline of 7.1% had been predicted by IDC. The shipments have improved in the U.S. (as the unit sales surged by 6.9%) and the other developed markets as the companies are replacing their aged machinery running Windows XP operating system, which is no longer supported by Microsoft (NASDAQ:MSFT). Despite this recent surge in shipments, I'm still concerned about the sustainability of this corporate strength in the long run. However, in the short term business will be robust.

Mobile Remains an Area of Concern

Although Intel as a whole continues to execute well, I believe the company is facing a significant risk in the mobile sector and has a poor mobile road map as evident from the sales in the company's mobile and communications segment, which declined by approx. 83% to $51 million during the second quarter. Intel is facing significant delays in rolling out its new high tech mobile chips and given the fact that the company already entered late, the company is lagging far behind its peers on this front. The new mobile chips, which were expected to be launched during the current year, are now expected to roll out in late 2015 or at the beginning of 2016 at the earliest.

The mobile and communication segment is weighing heavily on the company's cash flows. The segment reported operating loss of $1.12 billion during the second quarter. This is in addition to $929 million of loss in the first quarter. The company is investing heavily in R&D to break into the mobile market and is expected to spend almost 35% of its revenues on R&D and MG&A in 2014 ($19.3 billion out of $55.34 billion).

Unfortunately, the chip maker has been late to the game but with its heavy investment in R&D the company is hoping it will be able to carve out a niche for itself. While the company has the resources and technical know-how, how successful it will be in mobile remains to be seen.

Returning More Cash to Shareholders

Intel announced that it intends to return more cash to its shareholders through increased share repurchases. Intel has returned nearly $90 billion to its shareholders in the form of dividends and share repurchases over the last decade. Intel's Board recently authorized an increase of $20 billion to its share repurchase program. The announcement does not come as a surprise as the company is expected to complete its previous authorization of $45 billion next year.

The company has finally stepped up its share repurchase program. Intel bought $2.1 billion worth of shares in the second quarter and is expected to spend an additional $4.0 billion to buy back shares in the third quarter. This is huge compared to $500-$550 million per quarter rate last year. However, one thing that concerns me is that the company has accelerated its buyback program at a time when share price is moving upward, as this would increase the company's cost.

In addition to returning cash to shareholders in the form of buybacks, the company is also expected to grow its dividends as it hasn't raised its dividends since 2012. Investors are hoping for a raise in dividend on the grounds of impressive results reported in the last quarter. Despite investor expectations, the company's next move regarding dividend growth would be interesting given the heavy buyback being targeted and increasing expenditure on R&D.

Valuation

The biggest chipmaker's shares have had an impressive run lately. Intel is up 30% YTD and 41% over the last year. The company's shares gained the most (nearly 25% in the last 3 months) after the company, on the grounds of increasing demand for its business PCs, raised its revenue guidance for both the second quarter and full year in June.

In addition to the equity gains, the company maintained its history of paying constantly growing dividends to investors even in the times when the company was seriously questioned for its lack of vision and late arrival to the tablet and the smartphone markets. Intel has a dividend yield of 2.7%.

Intel is currently trading at a discount compared to its peers. The company is trading at EV/EBITDA of 7.5 as compared to the 7.9 of the peer Advanced Micro Devices Incorporation (NYSE:AMD). It has price/earnings of 18.1 compared to 67.6 of AMD and 24.3 of the industry. Moreover, the company has a price/book of 2.9 compared to 5.7 of AMD and industry average of 3.2. Finally, the company has a forward price/earnings of 14.3 compared to 18.7 of AMD.

Conclusion

Intel's quarterly results and the next quarter guidance of continued growth in PC business were largely in line with its preannouncement. Although the PC unit is reporting promising results, I believe they aren't going to continue for the long term. Moreover, the mobile unit is a major drag on the company's profitability and the management really needs to focus on this potential area of growth. While the market has responded positively to the earnings, I wouldn't get too excited on the earnings beat as the company is still facing some potential risks in the long term. While I see a limited downside from current levels, there isn't much upside potential either, especially after the recent run. I prefer to remain on the sidelines till I'm convinced about Intel's success in mobile and long-term growth potential in PC sales. For dividend investors, the company continues to offer a healthy dividend and is returning more cash to shareholders. Holding your investment in Intel seems to be the best strategy at the moment.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.