Why Intel Looks Like A $40 Stock To Me

| About: Intel Corporation (INTC)
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Summary

Intel has produced massive gains for investors patient enough to hold on.

The dividend isn't what it was, but still pays well.

I think Intel is worth about $40 right now, implying 10% upside.

Tech giant Intel (NASDAQ:INTC) has been one of the great turnaround stories in mega-cap stocks I've ever personally witnessed. The company was left for dead a couple of years ago; the PC market was allegedly dying and clumsy old Intel was unable to adapt to the changing times. Many investors stuck with Intel during those dark times when others didn't and those investors have certainly had the last laugh. Intel shares have doubled since their lows at the end of 2012 and have paid out $1.80 in dividends as well, boosting total returns further. With the business still strong but the stock up so much, is it time to dump Intel or is there more left for shareholders to reap? In this article, I'll take a look at Intel to see if it has a place in a value investor's portfolio.

To do this I'll use a DCF-type model you can read more about here. The model uses inputs including earnings estimates, which I've borrowed from Yahoo, dividends, which I've set to grow at 7% per year and a discount rate, which I've set as the 10-year Treasury rate plus a risk premium of 5.75%.

2013

2014

2015

2016

2017

2018

2019

Earnings Forecast

Prior Year earnings per share

$1.89

$2.24

$2.38

$2.59

$2.83

$3.08

x(1+Forecasted earnings growth)

18.50%

6.30%

8.98%

8.98%

8.98%

8.98%

=Forecasted earnings per share

$2.24

$2.38

$2.59

$2.83

$3.08

$3.36

Equity Book Value Forecasts

Equity book value at beginning of year

$11.55

$12.89

$14.31

$15.87

$17.60

$19.50

Earnings per share

$2.24

$2.38

$2.59

$2.83

$3.08

$3.36

-Dividends per share

$0.90

$0.96

$1.03

$1.10

$1.18

$1.26

=Equity book value at EOY

$11.55

$12.89

$14.31

$15.87

$17.60

$19.50

$21.59

Abnormal earnings

Equity book value at begin of year

$11.55

$12.89

$14.31

$15.87

$17.60

$19.50

x Equity cost of capital

8.00%

8.00%

8.00%

8.00%

8.00%

8.00%

8.00%

=Normal earnings

$0.92

$1.03

$1.14

$1.27

$1.41

$1.56

Forecasted EPS

$2.24

$2.38

$2.59

$2.83

$3.08

$3.36

-Normal earnings

$0.92

$1.03

$1.14

$1.27

$1.41

$1.56

=Abnormal earnings

$1.32

$1.35

$1.45

$1.56

$1.67

$1.80

Valuation

Future abnormal earnings

$1.32

$1.35

$1.45

$1.56

$1.67

$1.80

x discount factor(0.08)

0.926

0.857

0.794

0.735

0.681

0.630

=Abnormal earnings disc to present

$1.22

$1.16

$1.15

$1.15

$1.14

$1.13

Abnormal earnings in year +6

$1.80

Assumed long-term growth rate

3.00%

Value of terminal year

$35.97

Estimated share price

Sum of discounted AE over horizon

$5.81

+PV of terminal year AE

$22.66

=PV of all AE

$28.48

+Current equity book value

$11.55

=Estimated current share price

$40.03

We can see the model produced a fair value of about $40 for Intel, about three dollars higher than it trades for as I write this. That is a moderate difference that would indicate that Intel is a buy right now, but what are we looking at? The model is intended to produce a fair value at which shares can be bought with some margin of safety. That means, with Intel trading roughly 8% lower than the fair value, shares look like a pretty strong buy right now. But let's take a closer look and see exactly what we're dealing with.

Intel's business has been very strong in the past couple of years to say the least. The company that couldn't innovate and was going to have to cut its dividend turned out to be an imposter; Intel has innovated its way out of a deep hole and did not cut its payout. In fact, Intel has been able to boost its revenue by more than $2 billion this year while posting the highest margins the company has seen since 2010. This has allowed earnings to begin climbing again after 2013's substantial and worrying drop.

Intel has done an extraordinary job of growing in the mobile space, the space that really matters in today's world. Standard media like PCs and servers will always matter and INTC needs to compete there. But the growth will come from tablets and phones as more and more computing power is taken away from standard methods and transferred to mobile devices where possible. This is where INTC has executed and this is why the stock has doubled; the company that was left for dead at $18 wasn't competing in the mobile space and now that investors believe, shares have moved up sharply.

It's also interesting that INTC has been one of the best performers in the Dow (NYSEARCA:DIA) over the past year as we've seen marked underperformance erased and strong outperformance the norm for 2014.

This, along with the dividend, has made Intel one of the best mega-caps to own in 2014 and given the company's momentum, I hesitate to say 2015 will be different.

And speaking of Intel's dividend, much was made of the lack of an increase in 2014 but we received news recently that Intel's dividend would be 96 cents in 2015, a robust increase of about 7% over 2014. That was much welcomed news for investors who had a hard time digesting the lack of an increase this year and shares were sent higher as a result.

The implied yield of 2.6% certainly isn't the 4% it was at the bottom in 2012 but it still ranks as a very nice yield in the world of tech mega caps. Intel, however, has committed to $4.9 billion in dividend payments next year (at the current share count) out of only $9.7 billion in FCF. I say "only" because Intel is a very, very capital intensive business and when you're spending half your FCF on dividends, buybacks become difficult to finance when you have to balance the development needs of the business. It's not as though Intel can't handle its capital returns, but 7% increases in the dividend may be harder to come by in the years to come, particularly with Intel's history of buybacks. It will be interesting to watch what mix of capital allocation management chooses in the future.

Overall the picture for Intel looks pretty bright right now. The business is very strong and although FCF has dwindled a bit in the past year, strong earnings momentum should help bolster that metric, allowing ample room for the higher dividend and buybacks that Intel loves so much. Next year looks to be another one of Intel's outperformance against the market given the boosted dividend and strong fundamentals. I think Intel's fair value right now is $40 and that means it's a buy.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within 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.