Most traders on the Street seem to agree that technology has strong positive secular trends. In light of this bullish backdrop, it is surprising that semiconductors, which feed all end markets in technology, garner little attention. Based on my research, I find that many semiconductors are substantially undervalued. Even one of the most heavily traded companies, Intel (INTC), has plenty of margin of safety. Advanced Micro Devices (AMD), Texas Instruments (TXN), and Broadcom (BRCM) are also bargains at current prices. They trade at 6.7x, 11.7x, and 10.8x forward earnings, respectively, which is bizarre given that the S&P 500 trades at 15.5x past earnings; tech ought to have higher multiples given growth expectations.
Perhaps nowhere are semiconductors most revealed to be undervalued than at Intel. This iconic firm is a free cash flow mating. Based on 11.6% per annum growth over the next six years and 2.5% into perpetuity, consistent operating metrics, and a discount rate of 10%, I find the rough intrinsic value of the stock is $50. This is at an 82.9% premium to the current value.
Source: Internal research. Note: Intel's EPS over the past 5 years.
Aside from the high intrinsic value, momentum has also been solid. The last five quarters have been solidly above expectations at an average of 11%. If you take a logarithmic regression of EPS over the last five years, you extrapolate 2016 EPS to be $3.98. This figure is in-line with the 10.7% annual growth that is expected for EPS over the next 5 years.
In order to derive meaning from my $3.98 EPS projection, we must take an exit multiple calculation that is appreciative of peer levels and the past. Intel has an average 5-year PE multiple of 17.1x despite versus a 11.6x current PE multiple. Moreover, the firm's current PE multiple is around 20% less than its industry's and sector's. Taking a conservative 2016 PE multiple of 16x and multiplying it by my 2016 EPS projection, I find the future value of the stock to be $63.68. Discounting backwards by a WACC of 10% yields a target price of $39.54, which implies a 44.6% margin of safety - well above the 20% that is recommended. This comes on top of an impressive 3.1% annual dividend yield and rising!
But AMD, TI, and Broadcom are also valuable at attractive prices. AMD is only 70.2% of its 52-week high despite high double-digit EPS growth and consistent results. Over the last 5 quarters, AMD beat expectations by an average of nearly 35%. While the company has had a rocky history of losses in its past, the long-term trajectory has been up. Even a multiple of 12x on 2016 EPS that factors in the expected small 7.5% per annum growth would yield a future stock price ($11.54) that, when discounted backwards at 10%, offers more than a 20% margin of safety. At the same time, the firm is valued at only 10.2x free cash flow. The Street currently has a $8.94 target price on the stock.
TI and Broadcom trade closer to their respective 52-week high than AMD does, but they still have excellent room for appreciation. TI beat consensus by 10.3% in the first quarter and similarly exceeded expectations in the preceding three quarters. Despite great results, the stock has fallen by an egregious 13.3%, while the NASDAQ was up 8.7% over the same time. Yes, the firm is 113% of its 5-year average PE multiple, but it still offers a dividend yield of more than 2%.
And Broadcom has an excellent quick ratio of 4.7 and a PE multiple that it is just one-third of its historical 5-year average. ROIC is strong at around 10% Given the historical cheapness, analysts are starting to become more bullish. Wedbush recently increased its rating on BRCM to "outperform" with a $40 price target, and the Street has boosted 2013 EPS by 15 cents to $3.22 . Apple (AAPL) and tablet manufacturer wins have also helped secure sustainable streams of free cash flow.
Additional disclosure: 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.