Intel…Are Shares Attractive At Current Levels? by Luke Neely, Better Investing Habits
On April 19, 1965, Gordon Moore (co-founder of Intel) wrote an article that would help shape an industry (the world for that matter). Technology companies across the global deal with the basis of this article every day. The concept from that article would come to be known as Moore’s Law, which states, “the number of transistors in a dense integrated circuit doubles approximately every two years.” That makes it an incredibly competitive environment, even if you’re the one constantly innovating. It’s important to note that Moore himself saw an endgame to the rate of chip progress. In 2015, he thought it would eventually reach a saturation point. He said, “I see Moore’s law dying here in the next decade or so.”
Today, Intel is a leading manufacturer of integrated circuits serving personal computers, communications, industrial automation, military, and other technologies. The company has four main business segments: Client Computing (62%), Data Center (26%), Internet of Things (4%), and Software and Services (4%).
Third quarter results were better than the midline outlook from the company with gross margins holding steady above 62%. Year-over-year revenue was unchanged, with growth in the data center, Internet of things and memory segments helping to offset the drop in the client computing segment. For the upcoming quarter, management says they expect revenue to come in around $14.8 billion and gross margins to stay around 62%.
In the most recent quarter, Brian Krzanich (Intel CEO), states, “We executed well in the third quarter and delivered solid results in a challenging economic environment. The quarter demonstrates Intel innovation in action. Customers are excited about our new 6th Gen Intel Core processor, and we introduced our breakthrough 3D XPoint™ technology, the industry’s first new memory category in more than two decades.”
M&A is likely to be a key factor for continued growth. The recent acquisition of Altera for $16.7 billion, or $54 per share in cash, is a prime example of this. The deal with Altera seems great on the surface and should help diversify their operations away from the microprocessor business (which may be maturing). The previous purchases of software businesses Wind River for ~$1 billion in 2009 and McAfee for ~8 billion in 2011 should allow the company to bundle software and hardware security in the future. So, are shares attractive at current levels?
Largest Semiconductor Company in the World:
Intel reported record revenue last year with revenue of $55.9 billion (~14% of the market). They are one of the largest chip makers in the world and hold a dominant position in the Windows operating system products. The company continues to hit record annual unit shipments for PCs, phones, servers, tablets, and the internet of things. They continue to drive personal computing while moving into new categories in the Internet of Things, wearables, and mobile. Being a behemoth in the semiconductor space, the company is persistently pursuing Moore’s Law.
Size and Expertise Allows for Scale Advantages:
Diversity and scale give Intel a unique opportunity to transact and compete in numerous products in the technology space. The market appears to waking up to the idea that Intel’s scale in manufacturing will give them a big advantage in securing mobile device business from the major players.
In addition to scale advantages, Intel benefits from their products’ ability to operate on multiple operating systems which are sold to customers. The company also benefits from their network of manufacturing, assembly and test facilities, and innovative culture. They continually lead the market in next-generation products that their customer can use to improve performance, energy efficiency, additional features and storage, and lower cost. R&D continues to sit at ~20% of sales or $11-$12 billion. This is a formidable competitive advantage if executed correctly (which they have done in the past).
The Company Appears Set-up for Growth:
There are over 1 billion PCs that are older than 3 years (my PC included). You know how frustrating it can be with a slow computer. There is a major upgrade cycle occurring right now as consumers upgrade or replace older, slower computers in the workplace and at home. In addition to the PC growth potential, Intel should benefit tremendously in the growing mobile, Internet of Things and wearables markets.
They exceeded their goal in 2014 by shipping over 40 million units for tablets. In the process, they became one of the biggest silicon providers to tablets. The launch of the first U.S. smartphone powered by Intel should help propel growth in this segment in the coming years. Internet of Things revenue growth was up 10% year-over-year, over $2 billion. The data center segment continues to grow and should be a big portion of Intel growth in the coming years.
Capital Intensive and Competitive Industry:
D&A sits over 15% of revenue making it a very capital intensive business. There can be competitive advantages to capital-intensive businesses in the form of barriers to entry (railroads, etc). However, normally you’d like to see limited competition in a capital-intensive business because the need to innovate and replace assets is a big risk to businesses in a competitive market. Their main competitors include Advanced Micro (AMD), IBM (IBM), NVIDIA (NVDA), Qualcomm (QCOM), STMicroelectronics (STM), and Texas Instruments (TXN).
The $20 billion in long-term debt is a concern, but $15 billion isn’t due for five years or more. Free cash flow of ~12 billion should help make the debt load manageable over time.
Shareholder Friendly Management Team:
Management has repurchased over $30 billion of stock over the last five years. Share count has decreased 14% during that time period. In 2014 alone, Intel returned $15.2 billion to shareholders through dividends and stock repurchases.
Management continues to do a great job on the acquisition front. We are excited about the bundle opportunities in software and hardware security through the recent acquisitions in Wind River and McAfee. The culture at Intel continues to lead the way in innovation in the semiconductor space. We expect to continue.
Intel is the leader in the semiconductor industry. Growth has certainly leveled off in the past few years, however, the industry continues to growth. The growing wearable and mobile markets, as well as the upgrade and replacement cycle for over 1 billion PCs, could re-accelerate growth over time. With shares trading at a FCF yield of 7.22%, EV/EBIT of 11.44, and dividend yield of 2.80%, we find shares reasonably attractive at current levels.
First Eagle | Bill Nygren | Third Avenue | Michael Price
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ABOUT THE AUTHOR:
Lukas Neely is a former Hedge Fund Portfolio Manager and author of the Amazon #1 bestselling book (valuation), Value Investing Edge: A Value Investors Journey Through The Unknown. His work has been cited on such sites at TED, Wall Street Journal, Bloomberg, ValueWalk, CBS, GuruFocus, and Seeking Alpha. He is also the co-founder of Vantage Research, the provider high-quality investment idea generation, serving investment funds, portfolio managers, and sophisticated investors. Lukas is also the co-founder of BetterInvestingHabits.org.
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