Intel Earnings Preview: Has The Company Finally Turned A Corner?

| About: Intel Corporation (INTC)
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The June 2014 upside surprise announcement was good news.

Ironically, it came from the legacy PC biz.

The dividend and free cash flow are key metrics for growth sustainability.

Our model indicates INTC still trading at a 17%-20% discount to intrinsic value.

The last time we wrote about Intel (NASDAQ:INTC) was May 20th, 2014, in this article, which followed a weaker Q1 2014 and a stock price that looked to be stuck around $25-$26 forever.

We've been long INTC for quite some time, and the stock has lagged the overall market considerably, after hitting a series of highs in the $28-$29 area in April 2012.

On the Q1 2014 conference call, while the gross margin guidance was decent for Q2 2014, the other metrics including Data Center were pretty punk. PC and Client revenues fell 8% sequentially for INTC in Q1 2014. Not too bad seasonally, but I think the Street was expecting better after the "death of the PC" was greatly exaggerated from late 2012 through 2013.

However, the upside revenue and gross margin pre-announcement for Intel changed all that, with reservations.

Here is a table of Intel's consensus EPS earnings estimates for the next three years, both pre- and post- the June '14 upside surprise pre-announcement:

INTC Consensus EPS estimates before and after upside surprise:

Post June 12th After q1 '14 rpt growth rate chg
2016 $2.29 $2.10 from 5% to 8%
2015 $2.13 $2.00 from 6% to 5%
2014 $2.03 $1.89 from 0% to 7%

* Source: Thomson Reuters consensus estimates and internal spreadsheet

Here is the change in consensus revenue estimates:

INTC Consensus revenue change pre- and post-announcement:

post 6/12 after q1 '14 rpt growth rate chg
2016 $58.1 bl $56.56 from 4% to 4%
2015 $55.87 $54.6 from 3% to 2%
2014 $54.55 $53.1 from 1% to 3%

* Source T/R consensus data and internal spreadsheet

Despite the good news around the PC improvement and the jump in INTC's stock price of close to 20% since the q1 '14 financial results were reported, we haven't added to our 2.1% position in INTC given the worries addressed in the article.

INTC's dividend of $0.2250 per quarter hasn't changed in two years (since June of 2012), and INTC's entire stock buyback over 2013 was dedicated to offsetting or absorbing insider selling last year.

It is Intel's capital generation (i.e. free cash flow generation) and Intel's capital allocation that will tell me whether the company has truly turned the corner on growth.

Consistent, steady increases in the dividend and accretive share repurchases (and a lack of insider selling) will make the stock look a lot more attractive.

The forward consensus revenue estimates are still calling for mid-single digit revenue growth the next three years of 3%, 2% and 4%, respectively, for a 3-year average of 3%.

In terms of valuation at $31 per share, INTC has a dividend yield of 3%, and is trading at 15(x) the 2014 EPS estimate, with 7% growth expected.

At 7(x) fourth quarter trailing cash flow and 16(x) free cash flow, I would rather own Hewlett-Packard (NYSE:HPQ) in terms of PC hardware risk and given the operating leverage of INTC's business.

Using intrinsic value estimates, our internal model values Intel at $50 per share, which I think is too aggressive, while Morningstar values INTC at $25, which I think is too conservative: spilt the difference, and the $37.50 "estimated" intrinsic value means INTC is still trading at a discount to fair value of 17% to 20%.

Not too shabby.

While PCs are still 62% of INTC's revenue, the Data Center segment as of the Q1 2014 quarter was 24% of Intel's revenue and nearly 50% of Intel's operating income. That segment is not to be ignored: DC grew revenues 11% in Q1 2014 and operating income 15% last quarter. If INTC can get both the PC and DC segments firing at once, INTC's future will look brighter.

Like Deep Throat advised Woodward and Bernstein in All the President's Men, the great movie about Watergate, to "follow the money," we'll follow the numbers and the dividend and free cash flow generation to determine whether INTC has truly turned a corner in 2014.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in INTC, HPQ over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.