Intel (INTC) reports earnings after the market close today and is expected to see a 23% decline in earnings per share to $0.50 versus $0.65 per share in the same quarter last year. The company has beaten expectations by an average of $0.04 in each of the last eight quarters but it is likely that the trailing earnings will be lowered to around $2.26 per share. While a continuation of poor PC sales may make the bears happy, the current price multiple is 30% below the near-term average and upcoming catalysts could improve sentiment.
Problems mostly Cyclical
The semiconductor industry is extremely cyclical and revenues can drop precipitously when business spending declines. Intel saw total revenue fall more than 9% from $14.2 billion in the third quarter 2011 to $12.9 billion in the first quarter of 2012 before rebounding in the last quarter. Expectations for the today's report are for a $300 million drop from the last quarter to $13.2 billion.
The reason for the drop in revenues, and much of the negative sentiment as of late, is the slowdown in PC business. The switch from PCs to tablets and smartphones is driving an estimated 8% decline in revenues for the company's PC client group which accounted for $8.7 billion or 64% of total revenue in the second quarter. While the trend away from PC is something the company needs to address, much of the recent decline in sales is likely cyclical instead of a structural shift from the product. PC sales are expected to fall 1.2% this year, the first decline in 11 years. Is this really news though? Investors had to expect some bad news given the global economic picture and slower business spending leading up to the rollout of new Windows products.
A Management Team that has Always Delivered
Despite the weakness in macro issues, management has delivered with an operating margin of 30.8%, above 95% of competitors in the industry. Even with a 34% payout ratio and a 4.2% dividend yield, management has grown the book value of the firm by 7.5% annualized over the last ten years. A return on equity of 25.4% is great in just about any industry, but it beats 96% of Intel's competitors in the semiconductor group.
The company had $13.6 billion of cash and short-term investments last quarter and cash flows from operations of $4.7 billion. Cash flow was more than enough to pay for $1.7 billion in investment and $2.2 billion in financing, including $1.4 billion for share buybacks. Even after recent weakness in shares, investors have been rewarded with a 7.1% annualized return over the last 10 years.
Next Year Presents Strong Catalysts for Growth
Windows has announced that it will only provide support for XP until April of 2014. While many businesses have already transitioned out of the system, next year should see an increase in desktop replacement.
While Win8 failed to impress the markets when delivered on Nokia's (NOK) new smartphone, next year brings the launch of touch-enabled Ultrabooks at lower prices that could better utilize the new software. Further, the lower prices should help to bring in the late adopters into the product line.
The company plans on launching Haswell in the first quarter. The new processor is expected to offer twice the graphics performance at significantly less power consumption than standard products.
Beyond any micro-level events, any pick up in the macro environment will help to drive sales in developed markets as well as continue the strong growth seen in emerging markets.
Even if trailing earnings come down to $2.26 and the trailing price-to-earnings ratio increases to 9.6 times, the stock will only have been cheaper 5% of the time over the last decade. While the stock saw much higher valuations before 2004, it has averaged 12.5 times since 2010. This average multiple is 30% higher than the current and upcoming catalysts could drive sentiment even higher.
Weakness in PC sales may seem like a structural problem but the company has responded to industry changes before and has always been able to adapt. Next year provides several catalysts for a return of sentiment and a rebound to the average price multiple yields a 30% upside on top of a healthy 4% dividend.