Saturday, September 29, 2012

Stock Valuation: Intel (INTC)

Disclosure: I am long INTC.

The PC industry has been under a lot of scrutiny lately. Many investors have concerns as to what the burgeoning tablet market will do to the PC and chip manufacturers. This is apparent by looking at the stalk contrast in share performance of companies like Dell (DELL), Hewlet-Packard (HPQ), and Advance Micro Devices (AMD) in contrast to companies like Apple (AAPL) and QUALCOMM (QCOM). One company that I think the market is presently undervaluing is Intel (INTC).

Intel is the world’s largest semi-conductor chip maker by revenue and by units shipped. According to the market research conducted by IHS iSuppli, Intel held 16% of the market share in 2011 with closest competitors being Samsung (SMSN) at 9% and Texas Instruments (TXN) at 5%. While its future might be uncertain, it is a cash cow today and it will continue to be for at least another five years as the tablet market becomes more established.

Based on my valuation which considered the business, financial, and valuation risk, I would consider this stock very low risk and give it a BUY recommendation at the price of 24.83. Investors should expect an average CAGR between 17% and 34% over a period of ten years. I would recommend reviewing fundamentals quarterly and when reaches a P/E of 16. I would recommend selling if it reaches a P/E of 30.  

Business Risk:
The business risk takes into account metrics that can be used to project the future profitability of the business.

Here we are looking for strong upwards trends in revenue, net earnings, cash flow, dividends, and book value. In the case of Intel, despite a period of flatness between 2005 and 2009, we see growth in net earnings, cash, and dividends with average growth rates over the period of 20%, 12% and 28% respectively. From 2006-2009 revenue dropped (mostly due to macro factors) yet revenue, cash, book value, and dividends grew indicating strong management. Revenue has since turned around.

The major concern on the chart above is the drop in book value from 2010 to 2011. This arises from an outlay of cash for the acquisition of Infineon Technologies Wireless Business Solutions (results in a debt to goodwill, a non-tangible asset, and a credit of cash, a tangible asset). Despite this recent acquisition, tangible book value is up 2.8%. Without the acquisition, book value would be up 7%.

It is also worth noting, gross margin, SGA to gross profit, R&D expense to gross profit, and net income have averaged 57%, 28%, 28%, and 18% respectively over the past 5 years.
Overall, Intel looks to be in good health and has little business risk. The primary risk being a decline of revenue due to soft PC demand, however the company has shown it can manage its expenses and still return profit to shareholders in the event of temporary revenue decline.

Financial Risk:
Under financial risk we are looking to see if a company has the means to pay of it’s immediate debt. Below is a chart which shows Intel’s cash, short term debt, and long term debt.

It is very clear that from the chart above that Intel could pay off its debt entirely today with its cash reserves. Below indicates the percentage of total debt to operating income.

From the chart above we see that Intel could pay off its debt in entirety using just over 40% of its 2011 operating income. Due to the large cash reserves and high cash flow, Intel has no financial risk.

Valuation risk:
Here are we want to make sure we are not over paying for our shares. All returns are going to be based on the price that you lock in at, so it is important to lock in at a price where you will get the return you want if the company does well. To do this we look at P/E and dividend yield over time.

In relation to its earnings Intel’s shares near the lowest they have ever been in the history of the company. Average High and Low P/E for the last 9 years is 30 and 16 respectively.  

The dividend yield of the company has been growing consistently over the last nine years with an average growth rate of 28%. 

Recommendation: BUY

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