Article Thesis

Intel (NASDAQ:INTC) has seen its share price come under a lot of pressure in the recent past due to some issues with its 7nm process that will lead to product delays. Intel has faced issues like that in the past as well, but has been easily able to withstand such headwinds. In fact, the company continued to grow at an attractive pace despite these stumbles. With macro tailwinds working in its favor, and with a valuation at a very low level, Intel seems like it could deliver attractive returns going forward.

Intel versus peers, INTC peersSource: Stock Rover

In the above table, we see that Intel screens very favorably versus peers from the semiconductor industry. Its valuation, both EV to EBITDA and price to cash flows, is the lowest in the group, while at the same time, it sports above-average fundamentals in terms of returns on capital, leverage (net debt to EBITDA), and shareholder returns. This combination of quality at an attractive valuation makes Intel look interesting right here.

Process Problems: Nothing Really New For Intel

In late July, Intel announced that its progress with its 7nm process is not in line with the timetable the company had originally guided for, or in other words, its new products will be delayed. This resulted in a hefty reaction by Mr. Market, as Intel’s shares were sent down to below $50 versus a 52-week high of ~$70.

Intel’s 7nm delay is, of course, nothing to cheer at, but on the other hand, this will most likely not be an extremely large issue for the company. Intel has had experience with similar delays in the past, and those did not break the company at all. The company had similar struggles with its 10nm process, which also led to product delays. Have these issues stopped the company from growing or even resulted in steep revenue shortfalls as competitors gained market share versus Intel? Looking at Intel’s revenue performance over the last 30 years, the picture is quite different:

ChartData by YCharts

The company has experienced strong growth for decades, and over the last five years alone, the company has increased its annual top line by about $25 billion, as revenues grew from around $55 billion to close to $80 billion. The fact that Intel was able to continue to milk its 14nm process quite profitably when its 10nm products were delayed shows that maybe Intel will be able to do the same going forward. As 7nm products are delayed by 6-12 months according to management, the company may just keep selling its 10nm products for another year. The recently accelerating revenues show that demand for Intel’s 10nm products is quite strong, and I don’t see any reason why this should change materially going forward. The fact that Intel will bring its newest process to the market with some delay will thus likely not at all break the company or lead to outsized revenue declines – something similar did not occur when Intel ran into problems with previous processes. Intel may just continue to milk its current product generation for another year, and in terms of cash flows and profitability, that could turn out as a win. Its established processes are efficient and provide strong margins, and that will not change as the company works on bringing its next-generation product to market.

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Intel’s current products are quite competitive versus what peers are offering even though those are in some parts on a 7nm process already. The competitiveness of Intel’s current process is showcased by the fact that Intel’s data-centric revenues grew by a whopping 34% year over year during Q2. This was, at least partially, possible due to a very strong revenue growth rate of 47% for the Cloud business – the biggest customers in the industry thus apparently like Intel’s offerings quite a lot and continue to increase their spending. Even the low-growth PC-centric side of Intel’s business generated a very encouraging 7% revenue growth rate during the pandemic-hit quarter.

Active In An Attractive Industry

Intel has not only delivered very attractive results during H1 of 2020 (despite the pandemic), but it also has a strong outlook going forward. This depends, to a large degree, on the very positive macro environment for the company. Our lives are becoming ever more impacted by technology, as our phones, tablets, computers are important for both work and free time. This will not reverse, but rather continue, as new products, from IoT to autonomous cars, will increase our technology exposure further. Data is all around us, and it needs to be processed either in the products we use or centralized in data centers. Demand for processing capacity will thus most likely increase for decades, which provides for a very positive market backdrop for Intel and its peers. In a growing market, many players can do well at the same time, of course. The Mega Data Center market, for example, is forecasted to grow from $20.5 billion in 2019 to $28 billion in 2025.

Not only is the semiconductor industry attractive in terms of the market size and market growth, but also the companies operating in this industry are also benefiting from quite attractive fundamentals:

Intel profitability versus peersSource: Stock Rover

Note: Profitability Industry Decile versus the tech industry as a whole

Intel is reporting above-average fundamentals versus its peer group, but even the peer average is quite strong. Returns on assets and invested capital are high, and both margins across the semiconductor industry are very solid as well. Intel, combined with Taiwan Semiconductor (NYSE:TSM) and Texas Instruments (NASDAQ:TXN), is even outperforming the already very solid peer group average.

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One could thus say that the semiconductor industry is a nice neighborhood thanks to an attractive market outlook and strong fundamentals, and Intel seems to be an above-average house in it – despite the issues around the 7nm delay.

Intel: Not Priced Like The Others, While Returning Huge Amounts Of Cash To Its Owners

Due to the above-average outlook and fundamentals for the semiconductor industry, one could expect that the players in this industry trade at above-average valuations. And that is true, at least for most:

ChartData by YCharts

Advanced Micro Devices (NASDAQ:AMD), NVIDIA (NASDAQ:NVDA), Qualcomm (NASDAQ:QCOM), and Taiwan Semiconductor trade at 25-71 times this year’s earnings, but two players in this group have a notably lower valuation: Broadcom (NASDAQ:AVGO) trades at 16 times 2020’s expected net profits, while Intel trades at just 10.3 times this year’s net earnings. For a company that has Intel’s fundamentals, that is active in an attractive industry, and that has grown its earnings per share by 16% during the most recent quarter alone, this valuation seems quite low.

The growth outlook for Intel may not be as strong as that of NVDA or AMD, but it is still not bad at all, and yet shares are valued as if there will be no growth ever again. That seems to be an unlikely scenario, I believe.

The very low valuation, however, makes Intel’s buybacks even more attractive:

ChartData by YCharts

The company is gushing cash, with free cash flows totaling $21 billion during the last four quarters alone. This has allowed Intel to spend $12 billion on buybacks during the same period (buybacks were paused during Q2 due to the pandemic), while Intel has also spent ample amounts on buybacks in 2019. Overall, its share count has come down by 10% over the last three years, and if Intel gets back to spending $15 billion a year on buybacks, that will accelerate meaningfully, as this equates to about 7% of its market capitalization.

Intel also offers an above-average dividend that yields 2.6% right now and that grows regularly. The most dividend increase occurred at the beginning of the year, while the five-year dividend growth rate is at a solid level of 7%. As Intel’s dividend is costing the company about $5.5 billion a year, it is covered by free cash flows by 4 times, even after all of Intel’s capital expenditures and R&D spending are accounted for. On that front, Intel is, by the way, clearly outspending its peers:

ChartData by YCharts

With $13 billion spent on R&D over the last year alone, Intel spends more than twice as much as its closest peer (Qualcomm), while it spends roughly 2.5 times as much as high-flyers NVIDIA and AMD combined. This vast amount of effort that Intel puts on research and development should pay off eventually through better products or more efficient production, assuming the company can attract engineers and scientists who are as competent as those employed by its peers. Intel’s huge R&D efforts are one of the factors why I believe that the market may be underestimating Intel’s long-term outlook, as Mr. Market continues to price Intel for a no-growth future.

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Takeaway

In case Intel does not manage to get on track with its 7nm process, competition could eventually hurt the outlook quite a lot. But the current estimate of a 6-12 month delay will most likely not derail Intel – the company has experienced something similar in the past, and this has not stopped Intel from growing continuously.

Intel is active in an attractive industry, sports above-average fundamentals, and offers attractive shareholder returns, and yet the market prices the company like it was struggling to keep its top line from declining. This has in the recent past not at all been the case, and thanks to huge R&D efforts and a strong market growth outlook, we believe that this will not be the case in the future, either.

There is some execution risk, and there are also some political risks such as a trade war, but overall, the risk-reward ratio seems to be skewed in favor of the bulls right here. Intel, at its current bombed-out valuation, looks attractive.

One Last Word

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in INTC over the next 72 hours. 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.



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