Intel: Buy This Deeply Undervalued Chip Stock Now

Oct.25.12 | About: Intel Corporation (INTC)

Just recently, Intel (NASDAQ:INTC) announced plans to expand its research facilities in Oregon with a roughly $3 billion dollar project. This large investment into an R&D building signals Intel's commitment to follow the money as the industry transitions to fewer PCs and more mobile devices. Intel remains the leader in semiconductor chip development, and at a stock price under $22, I consider it a buy.

Unquestionably, the PC industry is hurting. PC sales are contracting even faster than analysts expected as tablets and smart phones eat away at the personal computing market. Companies like Dell (NASDAQ:DELL) and Hewlett-Packard (NYSE:HPQ) are struggling mightily, while Microsoft (NASDAQ:MSFT) attempts to appease consumers with Windows 8 and the Surface. Intel, the leading chipmaker for desktops and laptops, however, has yet to take a large share of the mobile computing market.

Allow me to make one thing clear, though, the PC is not dead. Tablets are great for browsing the internet, reading books, listening to music, and watching videos, but for actual content creation, they are vastly inferior to a desktop or laptop. Businesses will continue buying PCs along with other content creators. That is a market mobile devices are not suited for.

Additionally, PCs are much more competitive in developing countries such as India and China. Consumers in less affluent nations are much more price sensitive than those in the United States. Many PCs offer more functionality at a lower price than a tablet like Apple's (NASDAQ:AAPL) iPad or Microsoft's Surface, therefore drawing more consumers. Moreover, the markets in China and India have a lot of room to grow compared to the U.S.

Intel's position in the PC industry has led the market to undervalue it during this decline. Investors seem to discount the fact that Intel is one of the most innovative companies in the world and is poised to take advantage of shifting trends in technology. Additionally, it knows how to manufacture cutting edge semiconductors domestically as well as abroad. Its commitment to new research and development only confirms Intel's dedication to remaining the leading semiconductor developer.

While Intel can rely on PCs to fuel revenues in the near term, it knows it needs to make a concerted effort in the mobile processor field in order to compete long term. The arrival of Windows 8, which Microsoft optimized for touch screen mobile devices, gives it a foot in the door. The high-end device of Microsoft's flagship tablet features an Intel i5 processor.

Companies such as ARM Holdings (NASDAQ:ARMH), NVIDIA (NASDAQ:NVDA), and Qualcomm (NASDAQ:QCOM) already have a head start in the mobile processor arena. ARM is the clear market leader. The company is a little different from most semiconductor developers. Instead of manufacturing chips, it only designs them and licenses its patents to manufactures. This gives them the advantage of being able to move quickly with changing technology. ARM designs are present in nearly 95% of all smart phones.

NVIDIA, Qualcomm, and Samsung are the leading chip manufacturers for mobile processors - most relying on ARM designs. Licensing deals with ARM significantly cut into margins. Companies must pay a licensing fee for each chip produced and sold.

If Intel can develop chips to compete with ARM architecture chips, its margins will outpace ARM chip manufacturers in the long run. Because it will not have to pay licensing fees, it will be able to provide their product at a lower price while making higher profit margins. Expect Intel's margins to improve if Windows 8 tablets are popular with consumers and Intel can develop a chip optimized for mobile computing.

The company that will give Intel the most competition and has the highest potential for loss upon Intel's entry to the mobile market is NVIDIA. NVIDIA has grown its product penetration in the tablet computing niche, which is exactly where Intel would logically begin developing mobile processors. It currently provides Microsoft with the processor for its low-end Surface along with chips for Google's (NASDAQ:GOOG) and Amazon's (NASDAQ:AMZN) tablets and many more.

Because NVIDIA licenses ARM designs it cannot move as quickly as Intel could in mobile computing. Ultimately, I believe Intel will grab a significant portion of NVIDIA's market share by providing better technology potentially at lower prices. Naturally, this will drive NVIDIA's revenues and cash flow down.

Today, the market is undervaluing Intel on just about every metric. Lumping it in with PC companies like Dell and HP has a drastic effect on the stock price. However, the stock is currently trading at a 50% discount to its 5-year average P/E ratio. Its current P/E is less than 10 compared to about 30 seen in the broad market.

The company consistently reports return on assets over 17% and a return on equity over 25%. Its margins are outstanding with 60% gross, 30% operating, and 20% net. Simply put, the company knows how to make a profit. It has $10 billion in cash to invest in developing technology and continue paying out its 4.2% dividend.

New competitors in the PC industry are unlikely, as it appears unattractive currently and has a high barrier to entry. Intel can safely focus on developing mobile chips for Windows 8 tablets like the Surface without losing much ground in the PC-laptop market.

All of these factors lead me to believe Intel is a good long-term buy. There is great potential for the stock to grow and the added bonus of an inflated dividend for the time being. The company is consistent in its earnings and is able to adapt to changing markets domestically and abroad. At a price under $22, I believe the market is severely undervaluing it.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.