Will Intel's Free Cash Flow Improve its Valuation?

You only gain valuable insight on your investments, and an edge, by applying metrics and analysis that not everyone else has ready access to. Thankfully, this isn't very hard.

The investing media remains antiquated and basic, focusing almost solely on the often misleading earnings per share P/E ratio, even though free cash flow is the only true lifeblood of any company.

At Complete Growth Investor, we calculate various measures of free cash flow on all of our stocks, from true free cash flow [TFCF], to structural free cash flow [SFCF], to -- where appropriate -- maintenance structural free cash flow [MSFCF].

Today, as it prepares to announce first quarter 2007 results, we look at the most recent free cash flow results at chip leader, Intel (INTC). Let's see how its value stacks up:

True free cash flow [TFCF] is cash from operations minus capital expenditures and minus tax benefits from stock options. Structural free cash flow [SFCF] -- what Warren Buffett calls "owner's earnings" -- is net income from operations plus depreciation and amortization minus capital expenditures.

Last year was of course difficult for Intel, but free cash flow was hit even harder than earnings per share. As you can see above, Intel's true and structural free cash flow both declined 44% in 2006, to below $5 billion, while earnings per share declined 38.5%, faring better because of a large stock buy back.

The balance sheet suffered as well, with cash and equivalents declining to $8.8 billion from $11.2 billion at the end of 2005. Diluted shares outstanding, however, thankfully also declined, going to 5.8 billion from 6.1 billion, reflecting a large share repurchase program.

But that was last year. The stock is going to trade on forward expectations, and this year a rebound is expected. With pricing pressures at least subsiding, and Intel apparently gaining market share again, the company is expected to grow net income and very likely free cash flow by about 25% this year. That puts the stock at 19x forward 2007 free cash flow and 20x forward EPS estimates.

The price appears OK for a leader of Intel's strength. But by comparison, Cisco Systems (CSCO) is currently trading at only 17.5x TFCF compared to Intel's 22x. Cisco is expected to grow 17% this year.

At any rate, at 22x current and 19x times potential TFCF, Intel’s stock isn't likely to reward investors with large gains in a year or less, but it should provide a decent margin of safety (downside risk of below 20%, even in a bad market).

We've taken successful positions on Intel in the past when it was in the high teens, about 10% lower than today’s price; the last few years, that's usually the price range – the valuation -- we wait for to act. That has worked well.

This said, given that Intel is likely to improve its business at least this year and next, we might be content to act at slightly higher prices later this year if need be, once we see some confirmation from the business. So time will tell.

Comments

[Tom B:]

Intel's profits are clearly suffering because they have to finish the process of driving AMD out of the market, but I am very comfortable with the stock over the long term.

2007 Apr 16 09:11 AM