A couple of weeks ago, I analyzed the third quarter results for chip giant Intel (INTC). At that time, I did not provide a recommendation for the stock, as I wanted to see how things shuffled out after the report. While Intel's revenues beat expectations for the quarter, Intel had issued a Q3 forecast that was below expectations, and then reduced that forecast during a September warning. Now that we are a few weeks removed from Intel's Q3 results, it's time to look at the name again today and see if the value is still there.
Reductions in estimates:
When Intel reported Q3 results, it gave Q4 revenue guidance of $13.6 billion, plus or minus $500 million. At that time, analysts were expecting $13.78 billion for the fourth quarter. Analysts have since taken down their estimates, and the consensus is currently at that $13.6 billion figure, which would be a decline of 2.1% over the prior year period.
Intel did beat by 8 cents on the bottom line for Q3, but remember, that was after a revenue warning. Also, the company had a much lower than anticipated tax rate. At the Q3 report, analysts were expecting about $0.54 for the fourth quarter. However, because Intel's gross margin forecast was very poor, analysts have reduced their earnings forecast. For Q4, the estimate now stands at just $0.46. In Q4 of 2011, Intel earned $0.64. Don't forget, they are buying back shares, so the fall in net income is even greater.
The following table, taken from Intel's analyst estimates page on Yahoo Finance, shows how Intel's estimates have come down, for more than just Q4 and this year.
In 2011, Intel earned $2.39 per share. 90 days ago, analysts were expecting the company to earn just that in 2012. That meant flat earnings, despite the buybacks. But since the warning and Q3 results, the forecast for 2012 has come down by 28 cents. That's quite a bit. Additionally, 2013 estimates have come down even more, and now analysts are looking for a second straight year of earnings declines.
Value or not?
Intel can be considered a good value name for some investors, because the company pays a decent dividend and is buying back stock. In fact, the company has one of the highest dividend yields among large cap tech names. There are two other names with 3% plus yields that I have compared Intel to in the past, Microsoft (MSFT) and Cisco Systems (CSCO). For consistency, I'll do the same comparison.
So the following table shows four items. Revenue and earnings growth for each names. For this table, I am using the current fiscal year for Microsoft (ending June 2013) and Cisco (ending July 2013), against Intel's calendar 2013 (it's fiscal year).
Intel certainly has the advantage in terms of a dividend, but does that extra less than 1% a year compensate for much less growth and a much higher valuation? Intel is trading at an 8.5% premium to Microsoft, but Microsoft gives you an extra 7 full percentage points of revenue growth. Also, Microsoft gives you positive earnings growth, and a fair amount of it. Intel trades at a 19.5% premium to Cisco. Cisco also gives you positive earnings growth, and almost 4 percentage points more of revenue growth. Based on these numbers, Intel does look a bit overvalued. The reasoning is simple, and it has to do with falling earnings, which I'll cover in the next segment.
Implications of falling earnings:
Investors sometimes don't realize why falling earnings are so important. Well, with a company like Intel that is buying back stock, it means that net income is falling at a faster rate. Consider the following. In the third quarter this year, Intel's earnings per share fell from $0.65 to $0.58, a decline of 10.8%. But Intel's net income fell by 14.3%. The table below shows how this has worked so far this year. Earnings per share are actual, net income is in millions.
Net income is important because it relates to cash flow. It is the first line in the "cash flow from operations" segment of a cash flow statement. Cash flow is important because the more cash Intel has, the more dividends it can pay and more stock it can buy back, in addition to growing the business. Cash flow from operations dropped by $1 billion in the first nine months of 2011. In the current Q4, analysts see earnings per share dropping from $0.64 to $0.46. Imagine how much net income will fall if earnings fall roughly that much. It will be even worse than the first three quarters.
Intel investors may need to realize that future buybacks could be limited and dividend increases may be slower than expected, due to the falling earnings. We've already seen it start to happen. Through the first nine months of 2012, Intel bought back $3.8 billion worth of shares. During the first nine months of 2011, they bought back $10 billion worth of shares. If net income continues to decline into 2013, buybacks could slow even more. That makes Intel even less of a value play. As a comparison, Microsoft bought back $1 billion worth of shares in its most recent fiscal quarter, the same amount that it bought back in the prior year's period. I can't give you an accurate number in comparison for Cisco for their quarter just yet, because they won't be reporting their quarter until November 13th.
It is the falling earnings that make Intel seem overvalued to me and a short candidate, because of the implications involved. Net income is falling, which means less cash flow from operations. That ultimately will hurt buybacks and dividends. When the company stops buying back as many shares, the diluted share count doesn't fall as fast, and may start rising. If that is the case, earnings per share would be further pressured, and that would push the valuation up even more. The stock is already overvalued in my opinion, so an even higher valuation makes it even more of a short candidate.
Current analyst opinions:
Currently, the average analyst rating for Intel is a 2.6, which implies a slight buy. Intel closed Monday at $21.84. The mean (average) price target for Intel is $23.88, and the median price target is $23.00. That means analysts do not see a ton of upside for Intel.
In comparison, Microsoft is rated as a 1.9, implying a good buy. Microsoft closed Monday at $29.63, and the mean and median price targets are $35.44 and $36.00, respectively. Cisco is rated as a 2.2, implying a weaker buy than Microsoft, but a stronger one than Intel. Cisco closed Monday at $17.49, with the mean and median price targets at $21.79 and $22.00, respectively.
Intel analysts don't believe the stock is a strong buy, and their opinion of the name has certainly weakened in recent months. The following chart from Yahoo's analyst opinion page, linked above in this section, shows how sentiment has changed recently.
So since the revenue warning (the two months ago column), we've gone from 24 to 21 buy or strong buy ratings. Those three ratings initially went to holds, but now we can see that one of those holds has recently gone to a sell rating. Of the 54 analysts currently with a rating, only 21 have some form of a buy rating. That's less than 40%.
Conclusion / Final Thoughts:
Intel just isn't as strong a buy as it once was. While a 4% plus dividend sounds juicy to most investors, it doesn't help if the stock keeps dropping, which it has been in recent months. Right now, Intel's revenues are expected to decline in 2012 and only show about 2% growth in 2013. Earnings are expected to fall in both years. Intel remains a top tech name because of its size, but that doesn't make it a great investment. The valuation is certainly well above of other names, and you're not getting as much growth. Falling earnings make this name unattractive. I've recommended lately avoiding Intel until the valuation comes down, meaning probably until about $20. With us almost at $22 currently, that means that Intel might be a good short candidate on valuation. That doesn't mean you have to short it today or tomorrow, but it is a name to consider.
Additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.