Buying the Dip: Intel Corporation

Is it possible to find a device that does not rely on semiconductors? Almost impossible. Semiconductors, in the form of microprocessors, memory chips, integrated circuits, is the bedrock of technology. Without semiconductors, there will be no 5G, IoT, AI and self-driving cars. Semiconductors make technology possible.

Since March, the semiconductor industry has largely recovered. A quick look at the SOXX, the iShares PHLX Semiconductor ETF, reveals the truth. The semiconductor industry has emerged from the pandemic stronger than before!

From ETF.com

So was it the wrong time for me to invest in the semiconductor industry right about this time? Is the global semiconductor market still in the beginning stages of a huge rebound or is the party already over? Will the rally persist?

Many questions but no easy answers.

There is strong demand for semiconductor products from the cloud industry, and the gaming and 5G markets, just to name a few. My opinion, call it my bull thesis, is that the fundamentals underlying the semiconductor market will continue to improve dramatically over the next couple of months and well into the next year.

I shortlisted 6 semiconductor stocks to look into (ranked by PE ratio):

1. Intel (PE: 8.9)

2. Micron (PE: 21.99)

3. Taiwan Semiconductor (PE: 27.57)

4. Qualcomm (PE: 48.91)

5. Nvidia (PE: 93.53)

6. Advanced Micro Devices (AMD) (PE: 156.2)

INDUSTRY PE RATIO: 35.6

Based on PE ratio, the amount that investors are willing to pay per dollar of earnings per share, Intel is the cheapest while Advanced Micro Devices (AMD) is the most expensive. Based on further research, I’ve taken action on Intel as a value play and AMD as a growth play.

Introduction: Intel Inside

Back when I was still a student in the 90s, I learnt that a good computer or laptop is one that has Intel inside. Intel chip was a valuable feature that one should look for when purchasing a computer.

Intel Corp is one of the world’s largest chipmakers. It designs, manufactures and sells microprocessors and other related products for the global personal computer and data centre markets. Intel’s major products include microprocessors, chipsets, embedded processors and micro-controllers, flash memory, graphic, network and communication, systems management software, conferencing, and digital imaging products.

With its business in the personal computer market having declined, Intel has expanded into other areas such as IoT, memory, artificial intelligence, and automotive. Intel has been active on the merger and acquisitions front, recently acquiring Altera, Mobileye, Nervana, Movidius, and Habana Labs in order to assist its efforts in non-PC spheres.

Results and Ratios

As at the end of June 2020 (2nd quarter report), Intel reported the following:

1. Gross Revenue for this 2nd quarter of the year INCREASED 20% YoY from $16.5 billion to $19.7 billion. Gross revenue from data-centric business increased 34% YoY while gross revenue from PC-centric business rose 7% YoY.

2. Net Profit GREW 22% YoY to $5.1 billion from $4.1 billion.

3. EPS Growth has been on an upward trend since mid-2015.  EPS this quarter was $1.19, UP 29% YoY.

4. Free Cash Flow GREW 37.66% YoY from $7.7 billion to $10.6 billion. Cash from operations generated in the first half year of 2020 was $17.3 billion. Free Cash Flow Growth over the past 5 years:

2015: $11.69 billion

2016: $12.18 billion

2017: $10.33 billion

2018: $14.25 billion

2019: $16.93 billion

From: Intel Annual Report 2019

5. Dividend Payout Ratio over the past few quarters have been consistently low, with the payout this quarter at 23.49%. Intel’s dividend payments have always been well covered by earnings.

6. ROE the 2nd quarter was 30.52%, an improvement from 26.81 a year ago. Intel’s average ROE is 23.78% (my criteria: above 15%).

7. ROA the 2nd quarter was 16.59%, an improvement from 15.29% a year ago. Intel’s average ROA for the past 3 years is 13.35% (my criteria: above 5%).

8. Current Ratio FY 2019: 1.98 (barely meeting my criteria of more than 2).

9. Quick Ratio FY 2019: 0.93 (barely meeting my criteria of more than 1)

10. Fair Value: Estimated to be between $63.53-76.45.  Thus, I was comfortable buying Intel at $49.12.

12. Dividend Yield: 2.67%. Intel’s average dividend yield for the past 4 years was 2.58%.

Why did I buy Intel?

  1. Growth Potential

As I’m generally satisfied with the health of its balance sheet and its potential in generating sales and revenue, I focused more on Intel’s growth and transformation from an outmoded PC business to a far more relevant and diversified business that develops products for IoTs, data centres, 5G, and memory and storage. I like it that Intel, in keeping with the times and adapting to industry changes, is focusing on its transformation from a PC-centric company to a diversified data-centric one.

From: Intel Annual Report 2019

Data Centre Group:

  • 3 main market segments in cloud service providers, enterprise and government, and communications service providers.
  • Comparing results from FY 2019 to results from FY2018, revenue from cloud service providers was up 13%, from enterprise and government was down 14%, and from communications service providers was up 6%.
  • Segment operating income dropped 11% from $11.5 (2018) to $10.2 (2019). Average operating income over 5-year period: $8.78 billion.
  • It is interesting to note that Intel owns over 95% of the data centre CPU market.
  • Main competitors in this segment: AMD & Nvidia.

Internet of Things and Mobileye:

  • Internet of Things-based solutions represent one of the fastest growing segments within the semiconductor industry, and Intel has positioned itself to take advantage of this growth sector.
  • Intel has a portfolio of “IoT Market Ready Solutions” (IMRS) that supports 5,000 new end-to-end deployments in more than 100 countries.
  • IoT operating income increased $117 million. Since 2015, the IoT segment has had an average revenue growth of 14% and operating income growth of 22% per year.
  • Mobileye provides driving assistance and automation solutions.
  • Mobileye’s product portfolio employs a broad set of technologies, covering computer vision and machine learning-based sensing, data analysis, localisation, mapping, and driving policy technology for ADAS and autonomous driving.
  • Mobileye operating income increased $102 million, compared to a year ago.
  • No specific competitor in this segment although any companies that use the ARM architecture or provide traditional wireless solutions such as cellular, WiFi and Bluetooth could be threats.

Non-Volatile Memory Solutions Group:

  • Provides next-generation memory and storage products based on Intel’s breakthrough Optane technology and 3D NAND technology.
  • While overall revenue increased in 2019 YoY, the segment had an operating loss of $1.2 million, down from an operating loss of $5 million in 2018.
  • No specific competitor but expect competition from other providers of NAND flash memory products.

Programmable Solutions Group:

  • Offers programmable semiconductors for a broad range of market segments such as communications, data centre, industrial and military.
  • Operating income dropped $148 million from $466 million (FY2018).
  • No specific competitor.

Client Computing Group (PC-centric business):

  • This PC-centric business is still the largest unit of Intel.
  • In 2019, Intel introduced the 10th Gen Intel Core processor-based systems built on 10nm process technology.
  • Operating income improved 6.7% from $14.22 billion (2018) to $15.2 billion (2019)
  • Main competitors in this segment: AMD and Qualcomm.

Not all segments of Intel’s business were profitable in the last financial year; only Intel’s Data Centre Group, IoT and Mobileye, and PC-centric business turned a profit. As a company trying to reinvent itself by launching into markets that are growing such as data centre processors and flash memory, and developing cutting-edge products, it’s normal for Intel to meet some roadblocks in meeting its growth and revenue objectives.

For example, Intel released its flagship Core i9-10900K processor in May this year.* While this processor might be the world’s fastest gaming processor, the market, as yet, has not adopted this new technology. What might be a roadblock to this world’s fasting gaming processor being adopted by the market? It remains to be seen how Intel’s new innovations such as the Core i9-10900k processor would help Intel maintain its market share and grow its profit.

During the past decade, Intel has made several operational missteps such as not capitalising on mobile computing, making unprofitable mergers and acquisitions such as the acquisition of Mcafee and fitness watchmaker Basis, and delaying the introduction of its 10nm processors, just to name a few. While Intel’s recent past has been marked by quite a few arresting operational and investment-related blunders, Intel has nevertheless managed to successfully diversified its business from a mature computer-centric business.

Even so, the semiconductor industry is a very competitive one, and several of Intel’s competitors such as AMD and Taiwan Semiconductor have already stolen quite a few of Intel’s lunches.

Notwithstanding these competitive and manufacturing headwinds and the many missteps that Intel had taken over the years in the past decade, I see Intel as having the innovative clout to take advantage of opportunities in the data centre/cloud computing, IoT, and gaming space to provide an attractive growth trajectory for the company in the foreseeable future. Intel’s products are highly complex and Intel does possess some outstanding resources for research and development. However, Intel can still fall behind its competitors in terms of technology innovation, acquisition and transfer, and find itself in a position where market forces move against it.

For now I’m recognising Intel for what it is, a chip juggernaut that has the potential to either maintain or grow beyond its “Goliathic” bulk. Intel still occupies the top spot in the global semiconductor market, owning 16.2% of the global semiconductor market share. I’m placing my bets on the potential long-term upside of Intel.

2. Value Play

On July 23, Intel released a statement that caused investors to head for the exits the next day. While lauding the company’s strong 2nd quarter result, the CEO also announced the delay of its next-generation chips. Intel’s 7-nanometer chip product would be delayed by 6 months (plan was to launch this product in 2021) and is not slated to be shipped until late 2022 or early 2023. This delay of up to 3 years is considered an eternity in the fast evolving world of semiconductors. This news, coupled with a hint of a possible outsourcing of the making of its 7-nanometer chips, caused Intel’s share price to plummet about 16% the next day, falling from $60.40 to as low as $50.59. Since that day, Intel’s share price has not gone above the 50 dollar mark (I invested in Intel at the price of $49.12).

This incident has doom written all over Intel. Is Intel now a hopeless case?

The news of the delay in launching the 7nm chips was no doubt devastating but I wondered if this delayed rollout alone could paint an all doom and gloom future for Intel’s overall business. In running a business, what more a global conglomerate, there are bound to be hits and misses. If it is not a design issue, it is a technology problem or a manufacturing hiccup, and so on and so forth. In the case of Intel’s delayed rollout of its 7nm chips, it was a manufacturing snag which could be solved by using another company’s foundry (possibly Taiwan Semiconductor).

This is just one more misstep in Intel’s long history of existence in the semiconductor industry. Will this misstep hurt Intel’s sales in the short term? Definitely. However one has got to look at this disappointing episode against the larger picture of Intel’s entire business operation. By the way, the competition among semiconductor companies is not just about chip size but also other variables such as power density, energy efficiency, and software support.

Intel’s revenue stream now has exposure to the data centre market, IoT and autonomous driving markets etc, which are all long-term growth areas of the semiconductor market that I find particularly attractive. There is still room and space within the industry for Intel to write several growth stories. Intel is well positioned for the future.

Intel is now trading at a low PE of between 8 and 9, substantially lower than its 10-year average of around 12.5. At the current PE range, Intel looks rather inexpensive relative to its rivals. Intel seems to concur by resuming its share buyback scheme which has been put aside since the start of the pandemic. On August 19, Intel filed a Form 8K: “Intel believes that its common stock is at the time of this announcement trading well below intrinsic valuation, and that these repurchases are prudent at this time, given the strength of the company‚Äôs balance sheet.” This accelerated share buyback plan is a strong vote of confidence in Intel shares.

Intel is a sound company by any measure although its share price now may not reflect this reality. However, I’m willing to bet on its price recovery, seeing that the share price appears to have found support in the $48-49 range. How long do I have to wait for price recovery I don’t know, but I’m playing the long game any way and find collecting dividends in the meanwhile to be remarkably satisfying.

p.s. There are many people out there who are pessimistic about Intel’s future**, just as there are many die-hard fans of Intel as well***. Perspectives from this 2 camps permeate online discussions and commentaries in almost equal proportions.

* https://www.pcgamer.com/intel-had-to-go-power-crazy-to-create-the-worlds-fastest-gaming-processor/

** https://investorplace.com/2020/08/intel-stock-is-a-trap-for-contrarian-investors/

*** https://www.forbes.com/sites/greatspeculations/2020/08/18/put-your-chips-on-the-table-with-intel-corporation/#516cdd303595

Disclaimer: I am only an amateur investor and nothing you read here on my blog constitutes financial advice.  I write here to detail my investments, strategies, and analyses.  Feel free to read but take action based on what I write here at your own risk.  Should you need financial advice, consult a licensed financial advisor.