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Thesis: For investors with a long-term perspective (5 years+) Intel (INTC) is a best-of-breed company well on its way to becoming a solid dividend play with attractive fringe benefits. Because of its well-defined price channel, valuation and headroom for payout expansion, Intel rewards buy-and-hold as well as well-placed option plays.

Profile: Intel has been a dominant player in the Silicon Valley for well over a decade, with more than 80% marketshare for PC CPUs. It operates three main groups:

The PC Client Group (74% of FY2010 sales) focuses on consumer-segment microprocessors and related chipsets for notebooks, netbooks and desktops, including wireless connectivity options.

The Data Center Group (20% of revenue) is responsible for products used in servers, workstations and storage as well as cutting edge applications used in data center environments.

The other groups (4% of revenue) include smaller businesses such as embedded, ultra-mobility, digital home and communications groups.

While the PC Client group is responsible for the lion's share of the revenue, the Data Center Group, focusing on enterprise technology solutions such as servers and workstations, is far more profitable.

The company invests in a large amount into R&D: the budget for FY2011, including merger and acquisition costs, is an estimated $15.7B. Intel owns a diversified portfolio of technology and investment holdings (SeekingAlpha).

Source: Standard & Poor's Compustat Company Profile (login required), Intel Q1FY2011 release

Fundamentals: INTC is trading near 10x P/E TTM and a projected 9x forward P/E. 52 week range is $17.60 - $23.96.

PEG ratio sits at an attractive .86 considering the significant dividend yield and 115B market cap. Forward-looking estimates seem well-established if not outright conservative, although the company is subject to cyclical technology refreshes as well as dips in consumer sentiment. Competition from its main rival, AMD, seems to be limited to entry-level segments. The company posted a large increase in gross margin YOY, from 70% in FY2009 to 76% in FY2010, but forecasts a drop to 64% for FY2011.

INTC has outpaced consensus quarterly estimates 8/9 last quarters, an impressive record. Analysts expect $.51 for Q2 FY2011, with results posting on 07/20, and yearly EPS in the neighborhood of $2.30.

Source: Yahoo! Finance, Fidelity Investments

Downside Protection: P/Book is 2.5 vs. industry average of about 4.

P/Sales is 2.6 vs. industry average of 3.4.

Most impressively, P/CF for the most recent quarter is 6.33 vs. industry average of 14.60--purchasing the company's future sales is less than half as cheap as the industry average.

One must emphasize Intel's size, its near-monopoly marketshare and technology advantage over rivals. It's difficult to come up with any other hardware company which so comprehensively dominates its respective field.

The company holds close to 12B in cash and 2.3B in debt, which works out to about $2.26 per share. It pays a significant yearly dividend of about 3.9% with only 30% payout ratio. The stock has 63% instutional holding and a short ratio of 1.2%.

Source: Yahoo! Finance, Fidelity Investments

Technicals: INTC is trading near $22.80, riding its 50-day SMA but significantly above its $20.83 200-day SMA. It's basically flat over 6 months after experiencing steady downward pressure earlier in the year, followed by rapid appreciation after Q1 FY2011 results which outpaced expectations.

MACD gave a weak sell signal on May 19th and currently sits at -.12, with a significant negative divergence of -.19.

RSI and Williams %R confirm the equity to be undersold since late May.

General Sentiment: Analysts are bullish on the equity primarily on the basis of valuation, with a mean target price of $25.70. Recent upgrades include independent outfits Ned Davis Research, Ford Equity Research and Market Edge, all posting upgrades to BUY in the last week.

Goldman Sachs is a notable exception with a SELL downgrade posted on May 19th (Business Insider). The note includes generally bearish commentary about the semiconductor sector as well as worries about weakening consumer demand and growing inventories.

INTC is widely held among tech stocks. It's the 6th most owned tech stock by hedge funds (SeekingAlpha). Known as dead money for the last ten years, it seems to have reached a tipping point--not only is the company cheap in terms of purchasing the forward revenue stream (see the Downside Protection section) but its book value per share has also never been higher.

Source: Fidelity Investments (login required)

Analysis: Near-monopolistic dominance, significant dividend yield and historically low valuation metrics: is Intel's story just too good to be true?

Some certainly believe so. The bearish case against INTC can be summed up in two words: phones and tablets. Worries about a collapse in personal computing, with consumers abandoning notebooks and desktops in favor of more mobile devices, persist. Since about three quarters of its revenue is derived from the retail-driven PC Client Group, any significant contraction in the PC market will be painful for Intel.

Compounding the fears, Microsoft (MSFT) has repeatedly made it a point to demonstrate Windows 8 as tablet-oriented and ARM-friendly (WinRumors.) Meanwhile, potentially disruptive Chromium OS powered laptops, also hardware-agnostic, lurk at the fringes of the marketplace (Endgadget).

While these concerns are not trivial, Intel bears overlook the following 3 key factors:

  • Intel's technology edge: No semiconductor company comes close to even measuring against Intel's R&D--it's a bit like US military spending vs. that of the rest of the world.

The recent announcement of breakthroughs in 3D transistors (C-Net) is just one instance in a long and storied history of remarkable achievements. Less than half a decade ago, Intel's hot and difficult-to-scale Pentium 4 architecture (Northwood/Prescott/Cedar Mill) was the laughing stock of the technology press. At the time, Advanced Micro Devices' (AMD) performance lead was nothing short of astonishing, and various premature obituaries were penned for Intel. Fast-forwarding to 2011, the second iteration of iCore chips crushes AMD's offerings on just about every single metric and the latter can only convincingly compete on price.

Recent proclamations about Intel's impending doom from the general direction of ARM headquarters (PC-World) seem similarly foolish. Even in a worst case scenario, where personal computing turns moribund within just a few quarters, Intel has the resources, both financial and intellectual, to architect ground-breaking technology applicable to the mobility space.

  • Intel's manufacturing edge: There are tens of billions in revenue to be had should Intel decide to rent its state of the art foundries. Recent rumors about a bid to become Apple's (AAPL) manufacturer for A4/A5 processors (AppleInsider) were not exactly discounted by a senior Intel executive, and that represents the tip of a very large iceberg.

Intel's foundries and processes are advanced enough to be highly competitive with manufacturers that specialize in ARM-based CPUs, meaning the company is positioned to capitalize, should it choose to do so, on the proliferation of phone and tablet devices using the architecture. It's elected not to do so, but instead attempt to refine its largely lackluster Atom platform, but that can change if industry conditions and consumer sentiment see a drastic shift.

To put it another way: there's no way for ARM manufacturers to compete against Intel in the x86 space (ArsTechnica) but Intel has not only the capacity but a leg up against the competition in the ARM space.

Heads, Intel wins--tails, it wins harder.

  • Intel is well-positioned to power the cloud: The Data Center Group brings in only about 20% of Intel's revenue but is set for a decade of sustained growth as data centers become de facto 21st century infrastructure equivalents to highways and power lines. Intel has not only products fit for the data center environment but close partnerships with all sizeable server and IT solution providers.

From an investment perspective, one of the most appealing things about Intel is that its dividend yield keeps increasing and that it has enough headroom (payout ratio of only 30%) to compete against some utilities--but the volatility of the stock makes option premiums appealing even when considering very conservative plays.

Since the price channel for Intel is so well defined, purchasing out-of-money puts or selling covered calls makes for outsized returns with next to no risk. A few examples:

Selling $23 September 17th covered calls nets a premium of $.55 per contract for a 9.5% annualized return (for comparison purposes only.) If the option expires, congratulations! You've just earned a better yield than most corporate bonds while also collecting a dividend. If the option is exercised, congratulations! You've just earned a better yield than a corporate bond AND you've returned an additional $1.25 per share, locking in a 5.7% return in the span of 3 months (or less.)

Selling $20 September 17th naked puts nets a premium of $.52 per contract for a 10.4% annualized return (for comparison purposes only.) If the option expires, congratulations! You've just earned a better yield than most corporate bonds. If the option is exercised, congratulations! You've just bought a world-class company with close to 4% dividend yield at a price of less than 8.5x forward P/E.

Intel is a world-class dividend stock likely to reward buy-and-hold on its own--but these cautious option plays serve as fringe benefits which can be reinvested on a quarterly basis to increase the position. After all, why compound at 4% when you can do so at 13-14%?

Source: Intel: Dividend Champion in the Making