Intel (NASDAQ:INTC) has done fairly well since 2013 started, up 56.64% in a little more than 20 months. That's on top of paying out $1.575 per share in dividends resulting in a total yield of 64.09% over the period before any benefits of reinvestment. However, looking at Intel over the last 3 and a half years, the company has had some challenges. Perhaps most notable, from its financial statements, was the decline in operating margins and asset turnover. I'll break down Intel's last three and a half years with a five point DuPont Analysis to show what I mean.
Table 1 contains all the metrics calculated in the DuPont Analysis.
To keep it easy to follow, I'll break down what we learn from each metric. For those of you that are already familiar with DuPont analysis, some parts may feel a little slow. For anyone who didn't study finance extensively, it may be a refreshingly easy to follow analysis.
The tax burden label can be counter-intuitive. Because the formula is supposed to multiply out to ROE neatly, the tax burden has to be stated in the format of "how much money did the company keep after paying taxes?" As we can see, Intel keeps around 71% to 77% of its income.
The same system applies with the Interest Burden column. It is a measure of how much money Intel is keeping. Now it certainly seems weird that the values are over 100%. That is because Intel regularly holds securities that provide gains and interest that offset the interest on its debt. The income that Intel is creating by investing is netted against the interest expense that Intel creates by borrowing. As you can see, in each period Intel's gains and interest received were larger than its interest costs.
One of the bigger concerns for investors is that Intel's operating margin is decreasing. It jumped back up in the second quarter, but the overall trend has clearly been down. That could be a significant concern. However, operating margins are calculated after a company writes off the money the company spent on Research and Development (R&D). There are benefits and drawbacks to that rule.
To shed some more light on operating margins I pulled out the R&D costs and created Table 2:
Looking at Table 2 we can see that the R&D expense is a major factor in operating margins. Even though R&D is expensed as incurred, the purpose of spending money on R&D is to create new products that will enhance the company in the future. Therefore, money spent on R&D should not be considered a regular expense. After adding R&D back to the operating income, we can see that the margins are not dropping near as fast as it looked like. In absolute terms, it is a drop of about 6% instead of a drop of over 12%. In relative terms though, the drop is even smaller. When the margins are over 40%, losing a flat 6% isn't near as damaging as when your margins are in the 20s.
The next clear takeaway should be that investments in research are constantly increasing. When a company beats earnings guidance by having significantly lower research and development costs, I'm not impressed. Intel is not only sustaining its research and development costs, it also is increasing them faster than inflation.
Asset turnover is calculated as sales divided by assets. The measure helps us see how well, or poorly, a company is utilizing its asset base to generate sales. Until the second quarter of 2014, each period we measured was weaker than the one before it. As you'll see in Table 3 that problem is stemming from a constant growth in assets. The continuous increase in assets does not appear to be generating new sales.
The leverage ratio computed in Table 1 had a bump up in 2012 but since then has been fairly static. Leverage is a measure of "Total Assets" divided by the book value of "Equity." Using Table 3, you can see the individual numbers for the book value of equity and assets. Unfortunately, the leverage calculated this way can be meaningless. The actual value of the equity position in the company may be worth substantially more than the book value.
Still using the information from Table 3 we can see that cash has been trending downward recently. A downward trend in cash makes me think the company is less likely to begin a more aggressive share repurchasing program. If the company was stock piling cash, I'd try to figure out what the company was using it for.
With Table 4 we can get more in depth on the leverage.
The first thing to recognize from table 4 is that the shares outstanding have decreased slightly from 2011, but pretty much stayed in the same area since then. That means the company is only repurchasing enough shares to offset the use of employee options, not enough to really increase your percentage of ownership by holding the shares.
The second thing to look at is the leverage as computed by dividing debt by the sum of debt and equity. For the purposes of the analysis, I treat ALL liabilities as debt, even though some are short term liabilities that may not create interest. One constant goal of effective management is to minimize the Weighted Average Cost of Capital (WACC). Companies do that by financing their operations with the ideal combination of debt and equity. Unfortunately, this metric can be volatile at times because swings in the price of a stock will swing their leverage. However, Intel for the most part has been using around 20% debt. Given how strong its operations are, I would feel comfortable with the company increasing that percentage. Generally speaking, the required return on debt is much lower than the required return on equity. However, Intel does operate in a very competitive environment and the choice to limit debt does reduce the potential risk for loss. In the current interest rate environment, I generally favor companies using more debt than they choose to use.
Intel's operating margins have fallen, but a significant part of its costs is coming from increased investments in R&D. That makes the reduction in operating margins significantly less concerning. The bloat in assets seems to have slowed, which is a good sign since its asset turnover kept going down. The leverage is at a reasonable level, even if I would prefer an increase. At the present time, I'm fairly neutral on the stock. Given the strong history of the company, the consistency of dividends and increases in research, I would feel comfortable including it in a diversified portfolio. I suppose that puts me just ever so slightly on the bullish side.
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