Can Intel Overcome This Sector Peer?

Jul.22.14 | About: Intel Corporation (INTC)

Summary

We pitch two companies from the technology (semiconductor) sector, Intel and Texas Instruments, against one another in the latest instalment of our Head-To-Head series.

The article focuses on the relative strengths and weaknesses of Intel and Texas Instruments based on business performance and sustainability/dividends/forecasts.

It ends with discussion of the current valuations of the two companies, and details whether Intel represents good relative value at current price levels.

Intel Background

Intel (NASDAQ:INTC) was founded in 1968 and is based in Santa Clara, California. It designs, manufactures, and sells integrated digital technology platforms worldwide. It operates through PC Client Group, Data Center Group, Other Intel Architecture, Software and Services, and All Other segments. The company's platforms are used in various computing applications comprising notebooks, desktops, servers, tablets, smartphones, automobile infotainment systems, automated factory systems and medical devices. It offers microprocessors that process system data and control other devices in the system, as well as chipsets, which send data between the microprocessor and input, display, and storage devices.

Team Money Research Rating

Our investment philosophy is to focus on company fundamentals and identify stocks that are displaying strong business performance, that operate sustainably and that pay a decent, well-covered dividend.

We analyze each company relative to the other on the following criteria within each of our two main buckets:

Business Performance

  1. Return on equity
  2. Return on assets
  3. Operating margins
  4. Quarterly revenue growth
  5. Quarterly earnings growth

Sustainability/Dividends/Forecasts

  1. Debt to equity ratio
  2. Interest cover
  3. Dividend payout ratio
  4. Forward yield
  5. Annual EPS growth forecast

Once we have analyzed the two companies based on the first two buckets, we can then assess whether they represent good value based on the current prices of the two stocks. We use the following criteria to assess valuations on a relative basis.

Valuation

  1. Forward price to earnings ratio
  2. Price to book value ratio
  3. Enterprise value to EBITDA
  4. Price to 3 year average free cash flow ratio
  5. 5 year price to earnings growth ratio

So, for example, a company that performs well compared to its rival on the first two buckets (business performance and sustainability/dividends/forecasts) and that is undervalued relative to its peer (based on the third bucket: valuation) could outperform its competitor going forward.

The table below provides the data that we will use to analyze Intel and Texas Instruments (NASDAQ:TXN) for the first two buckets.

Stock

Intel

Texas Instruments

Business Performance

Return on equity

18.22%

21.20%

Return on assets

9.77%

9.47%

Operating margins

25.72%

23.80%

Quarterly rev. growth

8.00%

3.40%

Quarterly EPS growth

39.80%

34.50%

Sustainability/Dividends/Forecast

Debt to equity ratio

22.27%

53.22%

Interest cover

N/A

27.84

Dividend payout ratio

48.00%

56.00%

Forward dividend yield

3.00%

2.50%

Annual EPS growth forecast

6.05%

13.42%

Click to enlarge

As you can see, Intel performs well in our first two buckets. Indeed, we're impressed with its profitability - particularly its return on equity, which is 18.22% despite the company employing very low levels of financial gearing of 22.27% according to the debt to equity ratio. Furthermore, Intel's operating margins and return on assets are slightly higher than those of Texas Instruments, while Texas Instruments is slightly ahead in terms of return on equity. This shows that both companies are able to deliver strong profitability and generate lucrative returns for shareholders.

In addition, quarterly growth rates for both Intel and Texas Instruments are highly impressive, although Intel is ahead of its peer on this front. For example, Intel was able to grow the top-line by 8% last quarter (versus 3.4% for Texas Instruments), while the bottom line increased by 39.8% (versus 34.5% for Texas Instruments), which is hugely exciting for shareholders and shows that both companies are able to deliver strong rates of growth.

In terms of dividends, investors may be surprised to see yields as high as 3% for Intel and 2.5% for Texas Instruments. While impressive, both yields could go higher since the payout ratios for the two companies are only moderate at 48% for Intel and 56% for Texas Instruments. Therefore, we feel that both companies could be considered realistic plays for income-seeking investors. Meanwhile, earnings forecasts favor Texas Instruments, although we believe that Intel's 6.05% forecast growth rate is still attractive.

Overall, a strong performance by both companies, but we feel Intel just edges out Texas Instruments owing to its lower debt levels and better growth numbers last quarter.

Valuation

Due to its slight outperformance of Texas Instruments, we would expect Intel to trade at a slight premium. Let's see if it does.

Stock

Intel

Texas Instruments

Valuation

Forward price to earnings ratio

14.78

18.63

Price to book ratio

2.83

4.96

EV/EBITDA

7.49

13.18

PEG

1.77

2.01

Price to free cash flow ratio

17.87

18.97

Click to enlarge

Contrary to our prediction, Intel trades at a discount to Texas Instruments on all five of our valuation criteria. Indeed, the discounts are not minor and, we feel, show that Intel offers great relative value at current price levels. For example, Intel's forward P/E is currently 21% below that of Texas Instruments, while its EV/EBITDA ratio is a whopping 43% lower. Furthermore, Intel scores more favorably in terms of the price to book, price to sales and price to free cash flow ratios. Therefore, we think that the valuation gap is too wide and that Intel could outperform Texas Instruments going forward.

Conclusion

Intel is a high quality company that posted impressive scores on The Team Money Research Rating System. Indeed, its scores were slightly better than those of sector peer, Texas Instruments, although the valuation bucket highlighted that Intel appears to offer significantly better value for money at current price levels. As a result, we believe that it could outperform Texas Instruments going forward.

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.