Given uncertainty in end market demand for technology, semiconductors have the opportunity to generate high risk-adjusted returns. I particularly recommend that investors consider backing smaller players in the field, like ACL Semiconductors (ACLO.PK) and BE Semiconductor Industries (OTC:BESIY) - the latter of which is only trading at 5.1x past earnings. Having provided investor relations services to tech firms in the past, I say with confidence that shareholder outreach will be critical in building value for these firms' uncertain macro trends. Despite the lack of visibility, investors should not be too quick to abandon their favorite semiconductor picks.
In this article, I will run you through my DCF analysis on Intel (INTC) and then triangulate the result with an exit multiple calculation and a review of the fundamentals compared to Broadcom (BRCM) and Advanced Micro Devices (AMD).
First, let's begin with an assumption about revenues. Intel ended FY2011 with $54B in revenue, which represented a 23.8% gain off of the preceding year. Analysts model a 11.6% per annum growth rate over the next years, but I think this is a little pessimistic, given that it is only 100 bps greater than expectations for the broader market. In any event, I accept the projection for the sake of being safe.
Moving onto the cost-side of the equation, there are several items to address: operating expenses, taxes and capital expenditures. I model that cost of goods will eat 38% of revenue over the next few years compared to 15% for SG&A and 15.5% for R&D. These estimates are roughly around historical 3-year average levels. I further project capex normalizing around 13% of revenue. Taxes are also estimated at around 27%.
We then need to subtract out net increases in working capital: we model accounts receivables as 6.5% of revenue; inventories as 22% of COGS; accounts payable as 7.5% of OPEX; and accrued expenses as 80% of SG&A. Free cash flow comes out to around $10.7B by 2017.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value $25.82, implying 4.1% downside. On the other hand, an assumed perpetual growth rate of 3% and a WACC of 9% would yield a $36.50 fair value figure, which comes on top of an impressive 3.1% dividend yield.
All of this falls under the context of impressive 2011 performance:
We surpassed $50 billion in revenue for the first time, after crossing $40 billion for the first time just last year. This was our second consecutive year of more than 20% revenue growth. Since 2009, we have added $19 billion to the top line. The investments we've made to innovate and to expand our capabilities are paying off. Let me highlight a few examples.
As the volume of traffic crossing the Internet continues to explode, this has left companies and individuals searching for simple ways to store, manage and access this flood of information. This mega trend led to a fantastic year for our Data Center Group, with revenue up 17% on record microprocessor units, exceeding $10 billion for the first time. But this wasn't just servers. Storage revenue was up 42% to a new record high, and our Embedded Communications Infrastructure business was up 18%, also to a new record high.
From a multiples perspective, Advanced Micro is the cheaper. It trades at a respective 11.5x and 9.1x past and forward earnings versus 11.2x and 10.2x for Intel and 21.9x and 11.1x for Broadcom. Assuming a multiple of 13x and a conservative 2013 EPS of $2.58, Intel could hit $33.54 - nearer to my bullish case.
Consensus estimates for Broadcom's EPS forecast that it will grow by 1.4% to $2.93 in 2012 and then by 10.9% in the following year. Assuming a multiple of 13x and a conservative 2013 EPS of $2.89, the rough intrinsic value of the stock is $37.57, implying 3.8% upside. In light of this limited upside, investors looking for exposure to semiconductors should consider Advanced Micro. The company recently acquired SeaMicro for $334M, which will expand presence in cloud computing. Ultimately, however, I believe that Intel is ultimately safer than Broadcom and Advanced Micro given its scale, brand name, and customer loyalty.
Disclaimer: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.