The latest trade war saga news that negotiations will continue in October provided some relief for Intel Corporation (INTC). Nevertheless, year to date, the company underperforms the S&P 500 by more than 12% and the PHLX Semiconductor index by about 29%.
However, is the situation so bad that the biggest company in the sector with a wide moat, dividend history, low debt, and healthy free cash flow deserves rock-bottom valuation? In my opinion, the answer is no, as there is plenty of evidence that says otherwise.
Intel Corporation is a part of my Mad Dogs of the Dow strategy. This strategy focuses on the Dow companies with the highest shareholder yield. Since the beginning of this year, it has significantly outperformed the Dow index.
One of the Cheapest Companies in the Industry
Let's start with valuation ratios. Across all four valuation ratios presented in the table below, Intel is priced significantly below the sector averages. Its trailing price-to-earnings (P/E) ratio is 11.7, and its enterprise value-to-earnings before interest, taxes, depreciation, and amortization (EV/EBITDA) ratio is 7.2. These two figures are the second-lowest in the whole PHLX index. By these metrics, the only company with lower valuation ratios is Micron Technology (MU).
According to the current P/E ratio, Intel is valued approximately 50% below the sector's median. Similarly, its EV/EBITDA ratio is 55% below the median.
At the same time, expectations for AMD are sky-high. With its P/E ratio at 167 and EV/EBITDA ratio at 82, AMD's valuation is approximately five to seven times above the sector's median.
Source: American Association of Individual Investors
When it comes to the cash flows from Intel to its shareholders, the company has the sector's fifth-highest dividend yield (2.5%). Besides dividend increases, Intel continually increases its share repurchases.
During the last four quarters, the number of total outstanding shares has decreased by 3.9% (net buyback yield). When dividend and buyback yields are combined, Intel's trailing shareholder yield is 6.5% (after rounding). In relative terms, the combined yield was the eighth highest in the sector.
Competition With AMD
Since launching its Ryzen processors in 2017, AMD regained some of its lost market share. At the beginning of 2017, its share in computer processors was 18.1%, which in the second quarter of this year expanded to 23.1%. Although a significant gain, this is more or less the average market share that AMD has had since 2012. With the current 76.9% of market share, Intel’s scale remains considerable.
While Intel had significant delays in deploying its latest 10-nanometer processor technology, beginning of August, the company launched its first next-generation Ice Lake processors for laptops. This should, to some degree, help fight AMD's aggressive pricing for its third-generation Ryzen chips.
Although in the short term AMD could gain additional market share, in the long term Intel’s wide moat should ensure the continuation of its dominance. In one part, the wide moat is based on its superior cost advantages realized in the design and manufacturing of its cutting-edge microprocessors. In the long term, for AMD, it is hard to fight Intel's unparalleled capital expenditure capabilities (CAPEX). For example, during the last four quarters, Intel's CAPEX was more than $14 billion vs. only $194 million for AMD.
The above-average CAPEX and R&D budget allows Intel to control the entire design and manufacturing process, while the majority of competition focuses on only one phase. For example, both AMD and Nvidia Corporation (NVDA) have only design and not manufacturing capabilities.
Wide moat manifests itself in above-average efficiency. During the last ten years, Intel's return on equity averaged 27%. Similarly, the average return on invested capital was 21%. By comparison, over the same period, AMD lost more than $1.1 billion in aggregate.
Long-Term Supportive Data-Centric Trends
The PC-centric business (CCG), Intel's largest unit, was up 4% and 1% in the first and second quarters respectively. Some of the increase is due to the customers buying ahead of possible tariff impacts. However, in the long term, market trends impacting this business segment will not be favorable.
In 2018, the CCG unit had a 52% share in the total revenues. In 2018, PC sales (desktop and portable) fell by approximately 0.5%. The forecast is that this trend will continue during the next five years. Thus, Intel’s PC-derived revenue will, in the best case, stagnate. In the worst case, we should see a single-digit annual sales drop.
Nevertheless, Intel is successfully evolving from a PC-centric firm to a data-centric one. In 2013, the data-centric business represented around 30% of sales, while in 2018 it increased to 48%. Intel's target for fiscal 2022 and 2023 is that data-centric revenues will increase by approximately $14 billion, at which point they will represent about 60% of total revenues.
Source: Intel Investor Presentation
The data-centric part of the company encompasses the Data Center Group (DCG), Internet of Things (IOTG), memory business (NSG), and Programmable Solutions Group (PSG).
The DSG unit represents approximately a third of the total revenues. Booming cloud computing will provide significant tailwinds for this unit. The forecast is that the global cloud computing will grow at an 18% compound annual growth rate (CAGR) until 2023.
The Internet of Things unit represents approximately 5% of the total revenues. Although small, it is growing by a significant amount. Since 2014, this unit has had an average revenue growth of 14% and operating income growth of 15% per year.
This unit includes Mobileye, a company that Intel took over in 2017. Currently, this unit is the global leader in the development of vision technology for Advanced Driver Assistance Systems (ADAS) and autonomous driving. Mobileye was an early pioneer of vision systems that allow vehicles to recognize hazards. During the first two quarters, revenues of this unit increased by a substantial 27%.
It is expected that by 2026, the global autonomous driving market will grow by 40% per year. With Mobileye's trailing twelve-month sales at approximately $800 million, market growth will boost Intel's long-term revenues and profits.
During this year, memory prices experienced a substantial decline. This decline significantly impacted Intel's memory business (the NSG unit). This unit represents approximately 6% of the company's sales, which during the first two quarters experienced revenue decline by 13%. However, it is expected that by 2024, the semiconductor memory market will experience double-digit annual growth. The expansion is fueled by numerous technological advancements, such as autonomous driving, 5G networks, growth of data centers, and cloud computing. All these trends fuel a sustained increase in digital content that needs to be stored, which makes memory chips a significant facilitator in the expansion of the data economy.
The Programmable Solution Group is Intel's smallest business unit and represents about 3% of annual sales. This unit offers products for a broad range of market segments, including communications, data center, industrial, and military. The market for these solutions is expected to increase with 5G implementation, and the forecast is that until 2023, it will grow by 9% per year.
Dividends and Buybacks Fully Covered By Free Cash Flow
Intel's dividend increases
Source: American Association of Individual Investors
The company has a history of dividend growth, and stock repurchase increases. Since 2012, the annual dividend increased by approximately 40%. During the trailing twelve months, the total dividends per share were $1.23, or 2.5%.
Besides dividends, Intel conducts regular share repurchases. From 2012 until the end of 2018, the company decreased the shares outstanding from 4.996 to 4.611 million. This corresponds to the average annual reduction of 1.3%. However, during the last four quarters, free cash flow has significantly increased. As a consequence, Intel tripled share repurchases, and during the same period, decreased the shares outstanding by 3.9%.
Source: American Association of Individual Investors
Compared to the fiscal years 2015, 2016, and 2017, stock repurchases increased substantially. During the last four quarters, they amounted to $10.5 billion. When combined with the $5.5 billion paid out via dividends, that total cash flow returned to shareholders was $16 billion, which was a record in Intel's history. On the other hand, adjusted for divestments ($3.4 billion), the trailing free cash flow was $18 billion and was more than enough to cover record cash flows to shareholders.
Low Debt Assures Continuation Of Dividends And Repurchases
At the end of the second quarter, the company had almost $12 billion in cash and cash equivalents. On the flip side, short-term and long-term debt combined was just below $29 billion. Thus, the net debt was $17 billion. This resulted in a net debt-to-EBITDA ratio of 0.58 and net debt-to-EBIT ratio of 0.84. Both figures are quite low. As the total stockholders' equity is $75 billion, the net debt comprises only 25% of the total capital.
A low debt level provides operational flexibility and assures that Intel can continue with its high dividend and buyback cash distribution policy.
Risks and Uncertainty
Intel operates in a cyclical industry, which will cause its profitability to fluctuate regardless of how successfully the company tailors its products for existing and new markets. However, the dominant market position, significant CAPEX capabilities, integrated design and production, and low debt levels will allow it to better handle volatile end-markets.
In 2021, Intel plans to launch a 7-nanometer technology. However, any delay, as we have seen with its launch of 10-nanometer processors, could lead to competitors capturing a part of the market share.
Trade war poses an additional risk, and new tariffs on both sides could disrupt product sales. Additionally, any new measures against Huawei would disrupt short-term sales agreements and profits. However, in the medium term, other companies, which are mostly Intel's customers, would overtake Huawei's market share.
Presently, a buyer has an edge because:
- Intel is successfully transforming from a PC-centric firm to a data-centric one.
- The data-centric markets are forecasted to grow between high-single digit and double-digit rates.
- The company is significantly discounted compared to the market averages.
- Intel continually increases its dividends and repurchases.
- The company's profitability fully supports cash returns to shareholders.
- Its debt ratios are quite low.
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Until my next update, be patient with your investments and give them time to grow!
Disclosure: I am/we are long INTC. 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.