Intel (INTC) may be experiencing problems with HDD shortages, but given its low valuation and entrance into high-growth areas, I believe that the company is favorably skewed towards reward over risk. I previously argued this case around 2 months ago and since then the stock has gone up by 9.2% while competitor Advanced Micro Devices' (AMD) stock went up by 16.3%. In particular, I believe that the emergence of the Ultrabook market will accelerate value creation and that increases in capex in 2012 are actually in the firm's best interest.
From a multiples perspective, both companies appear incredibly cheap. Intel trades at a respective 11.1x and 10.1x past and forward earnings, while offering an impressive dividend yield of 3.3%. AMD, meanwhile, trades at a respective 4.1x and 8.9x past and forward earnings, while offering a dividend yield of 2.2%. Skepticism about demand is holding back value for both firms. Analysts currently rate Intel a "buy" and its competitor more of a "hold".
At the third quarter earnings call, Intel's CEO, Paul Otellini, noted strong performance:
I am very pleased to report another very strong quarter for the company with the highest quarterly revenue, earnings, earnings per share and microprocessor unit shipments in Intel's history. In particular, we were very pleased with the momentum in our notebook PC business and consumer demand for our industry-leading second-generation Intel Core processor family. Relative to the third quarter of last year, our notebook business saw double-digit unit growth, leading to record microprocessor unit volume and revenue.
Trends inside the quarter played out largely as we expected. While consumer demand in mature markets like Western Europe and North America remained soft, Enterprise PC demand remained strong and consumer demand in emerging markets continued to rise year-over-year. China was up 12%, India 21%, Turkey 14% and Indonesia 23%.
This was the sixth consecutive record revenue quarter. It is particularly noteworthy that 2 of the top 3 global PC markets are emerging ones: China (#1) and Brazil (#3). As the vast majority of Intel's sales come from the PC market, this development is considerably beneficial to the firm. The exposure to these high-growth regions will hedge against domestic risk while lifting upside.
While HDD shortages, complicated by floods in Thailand, have driven value destructive increases to computer inventories, I remain bullish on the industry for several reasons. First, there is the release of Windows 8, which will provide an attractive entry opportunity for investors. Then, there is the rise of the Ultrabook, which may make up as much as 50% of the consumer notebook market by the beginning of 2013. The first generation of Ultrabooks are just starting to surface; future ones will feature touch screens, always-on capability, and lighter designs. In my view, this represents the future of the PC market and, as an aside, a major opportunity for Microsoft (MSFT) to transform quicker than its competitor Apple (AAPL). Third, Intel is beginning volume production of Ivy Bridge in 22 nm technology. This will help push forward the shift to 3D transistors and drive strong returns to the semiconductors firm. Fourth, the firm has extended its collaboration with Google (GOOG), which will drive greater revenue from mobile computing.
Accordingly, I believe that the firm's factory expansion in 2012 will help to meet future demand that is above the market's expectations. With that said, checks have thus far indicated low notebook production and microprocessor production may be at a surplus. Although I anticipate the tide changing, this remains to be seen.
Consensus estimates for Intel's EPS are that it will grow by 19.5% to $2.45 in 2011 and then by 4.5% and 6.6% more in the following years. Assuming a multiple of 14x and conservative 2012 EPS estimate of $2.50, the rough intrinsic value of the stock is $35. This implies a 36.4% margin of safety and is more than enough to consider the company a value play. Management is also very shareholder-friendly with its capital allocation policy, thus making the company attractive to income investors.
On the other hand, consensus estimates for AMD's EPS are that it will decline by 2% to $0.48 in 2011 and then rise by 33.3% and 35.9% in the following two years. Assuming a multiple of 11x and a conservative 2012 EPS estimate of $0.62, the rough intrinsic value of the stock is $6.82. This implies a 19.2% margin of safety and does not meet the threshold that I consider to be a value play.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in INTC over the next 72 hours.