Compared to Advanced Micro Devices (AMD), Nvidia (NVDA), and other semiconductor stocks (SMH), shares of Intel (INTC) have fallen disproportionately in 2019 (Figure 1). In addition to the same negative outlook about cloud spending cuts, weakening gaming demand, and the stalemate of trade talks, Intel has had enough of its own issues which include the shortage of CPUs, the multiple delays of the 10nm chips, and looming CPU market share losses to AMD. As a result, Intel’s current 10x forward PE is near a 6-year low. In comparison, despite a consensus expectation for a 19% EPS decline in fiscal 2020, Nvidia still has a 24x forward PE. AMD’s 33x PE is even more robust, reflecting its solid gains over the last several quarters in data center and PC CPUs. That being said, with all the information already out for a while, the question still remains if Intel’s stock price has properly reflected the recent mostly negative information. Thus, it may be time to look forward and revisit the fair valuation of Intel’s stock. This is what I set out to do in this post.
As the bellwether chipmaker, Intel is never short of challenges. After a disappointing 1Q, while the short-term CPU shortage may linger on, the server-CPU inventory digestion will also continue in 2Q. Because of its sheer size, Intel has been most affected by corporate IT spending cuts and memory price declines, and both negatives have not shown any signs of easing. As a result, previous industry expectation of a stronger 2H seem less likely amid deteriorating China demand and the Data Center Group’s revenue decline. For the rest of 2019, Intel’s 2Q sales are expected to decline and maybe rebound in 2H at a low single digit. In 1Q ER, Intel’s 2Q and 2019 sales guidance were 7% and 3% below estimates.
More importantly in the long run, Intel’s main challenge comes from the serious threat on its PC-CPU market share and the server-CPU market share from AMD. At the recent Computex, Intel’s archenemy AMD released the long-waited third-generation 12-core Ryzen 9 3900X microprocessor chip. While Ryzen 9 is based on AMD’s new 7nm Zen 2 manufacturing process, it boosts a clock of 4.6 gigahertz with a base clock of 3.8 GHz, packs 70 megabytes of cache storage with a cost of $499, much lower than the $1,189 price for Intel’s 12-core i9-9920X. Other than beating Intel on price, the company said that its new chip beats Intel’s chips by 14% in single-threaded tasks on the Cinebench R20 benchmark test and 6% on multi-threaded workloads. The Ryzen 9 3900X also boasts a thermal design power rating of 105 watts, compared with the 165 watts TDP of Intel’s Core i9-9920X. Clearly, for the first time, Ryzen 9 ion 7nm is AMD’s first attack on Intel’s i9 on 14nm on cost, performance, and power levels. As AMD’s gain may be Intel’s loss, AMD’s new product lineup suggests that AMD's Q2-Q3 sales growth will remain robust, at the expense of Intel’s market share.
Forward P/S Valuation
Since AMD has become a serious contender on Intel’s CPU market shares, the future revenue gain should be the first thing on Intel shareholders’ minds. Therefore, I first used a revenue-based valuation approach, “Sales Franchise Value Model” (SFV), to convert the forecast revenue to a corresponding stock fair value:
The Sales Franchise Value (SFV) model computes two parts of the stock value. The first part includes the market value for constant growth profitability. The second portion is the excess profit growth over shareholders’ expectations. This is a model to produce a stock valuation which reflects both future revenue growth and margin changes. The most sensitive factor is the annual revenue growth rates which are assumed to fluctuate between 3% and 5%, per Street’s estimates. The discount rate has been increased from 15% to the recent 18% level. This is due to a significant increase in Intel's risk level after Intel’s 1Q downside guidance and AMD’s market share gain with Ryzen and EPYC. The less sensitive gross margin is expected to be around 60% for the year. Given the various forecasts, the SFV computes the forward P/S multiple to be between 3.66 and 4.02. Using a forward four-quarter sales forecast of $69.89 billion, Intel’s revenue-based fair value should be between $57 and $62. Accordingly, Intel’s share is currently undervalued by about 25%-35% (Table 1).
Forward P/E Valuation
Different from AMD, Intel has long passed the point of profitability. Therefore, the market has demanded the company produce reasonable and sustainable profit. On that front, for the better part of 2019, gross margin will still be a struggle. With a sales decline in sight, the EPS growth has to come from the cut in operating expense. Yet, the expected 10nm ramp-up will definitely pressure gross margin. AMD’s low price competition will also impact cost. Intel’s gross margin looks to stay between 58% and 60%.
If investors choose to value the stock with profitability, it's the sustainable forward earnings that's important to focus on. To this end, I used the following forward earnings-based valuation approach to price the stock:
Where P/E* is the fair forward PE, k is the required rate of return, ROE is the forward return on equity, and g is the long-term earnings growth rate. The economics behind the “Intrinsic PE Model” is based on the premise that the market will pay a higher multiple for the company’s ability to consistently generate a higher return on equity than shareholders’ required rate of return. In this case and as in the previous section, the required rate of return (K) is estimated between 17% and 18%.
As outlined in the previous section, Intel's 2019 3% sales growth likely limit gross margin to no more than 60% , which leads to a ROE around 24%-26%. The pivotal earnings growth rate is projected from the 3%-5% 2019 sales growth and gross margin estimates to be between 12% and 13%. As a result, the IPE model would give the stock a fair forward PE between 10.17 and 11. Using a forward four-quarter EPS of $4.55, Intel’s earnings-based fair value should be between $46 and $50 (Table 1). Accordingly, Intel’s share is mildly undervalued by 5%-10.
Compared to its major rivals, AMD and Nvidia, Intel may appear to be unfairly treated by the recent market wrath. Both the earnings valuation and revenue valuation reached a similar conclusion that the stock is undervalued. While Intel struggles to defend their revenue growth and market shares, both the macro picture and the company’s technology are not on their side. As a result, Intel’s 1Q downside guidance and AMD’s 7nm product roll-out should serve as a wake up call to shareholders that Intel’s long-standing size advantage over AMD may not have a long shelf life. The fact that the current market has priced Intel’s stock more towards its profitability than revenue growth suggests an alarming possibility that Intel may lose a significant market share to AMD.
Disclosure: I am/we are long NVDA. 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.