Profit From Intel's Colossal Failure

Ken is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Normally, when a business delivers results that fail to meet investors' expectations, it is due to poor financial performance.  Today, I believe I have found the exact opposite situation: a business that will miss expectations by continuing to survive and thrive but is currently priced to fail.   Wall Street and the average investor seem to believe that Intel (NASDAQ: INTC) will be going out of business in about five years. I believe that Intel will miss that projection by a wide margin. 

Intel dominates the market for the processors that drive our computers.  It only has one real competitor in that space, Advanced Micro Devices (NYSE: AMD) -- and to refer to AMD as a real competitor to Intel takes quite a stretch.  A quick check of Yahoo! Finance lists Texas Instruments (NASDAQ: TXN) as a direct competitor of Intel as well. 

The reason I believe it is such a stretch to call AMD a real competitor to Intel is that its business can most kindly be described as a basket case. 

It is projected to lose $221.34 million in the current fiscal year, ending Dec. 31, and an additional $35.7 million next year!  It has a current debt to equity ratio of 3.8 to 1, and given the projections for this year, that will get worse.  With current shareholder equity of only $538 million, these projections would equate to a loss of 41% of total equity in 2013 alone!  It would border on insanity to consider this business a real competitor to a cash-gushing giant like Intel.

Is Intel really priced to fail?

It is hard to believe that anyone believes Intel is going out of business, but, a dispassionate analysis of the numbers seems to indicate that is the current sentiment on Wall Street. 

Last year, Intel generated cash from operations of almost $18.9 billion, against a current market cap (less cash on hand) of $95 billion.  This means that minus its existing cash hoard, this business is priced at 5.03 times its cash-generating capability.  Even when considering the substantial capital expenditures Intel makes in order to maintain its dominant position, it maintains a multiple of 10.5 times free cash flow when a five-year average of capital expenditures is applied.  This is simply an absurdly cheap valuation for a business that has no real competition in its primary business and generates almost $19 billion/year in cash flow.

Valuation: Intel Versus the Competition

                                              INTC               TXN                AMD

P/E Current                             9.83                 22.7                 -1.61

P/E Forward                            9.97                 15.66               -51.2

Proj. 5-Yr. Earnings Grwth.      9.7%                 8.3%               10.2%

Debt to Equity                          0                     0.52                 3.8

Gross Margin 5-Year              60.7%               50.2%               39.5%

Net Margin 5-Year                 20.2%               16.7%               -8.0%

ROA 5-yr. average                14.6%               14.3%               -6.9%

ROE 5-yr. average                20.2%               20.6%              -45.8%

ROC 5-yr. average                17.3%               16.9%              -10.2%

As these numbers reveal, Intel is performing financially much like Texas Instruments, but is priced much closer to the valuations assigned to Advanced Mirco Devices.  If Intel were to simply be assigned a market value based on a P/E ratio equal to Texas Instruments, shareholders would be rewarded by with a 50% return on investment.

Is there any rational explanation for this discrepancy?  Well, Wall Street dislikes Intel at the moment because it's been late to the party in the chip market for mobile devices, currently dominated by Qualcomm (NASDAQ: QCOM)

Intel has made it clear that it intends to establish a presence in the chip market for mobile devices, and it certainly has the wherewithal to do so.  I am quite sure that this is not news that pleases Qualcomm, but since it's slightly larger than Intel in market capitalization, I doubt it's shaking in itsboots. 

The same probably cannot be said for two of the smaller players in this segment: NVIDIA (NASDAQ: NVDA), with a market cap of $7.87 billion, and Marvell Technology Group (NASDAQ: MRVL), with a market cap of $5.5 billion.  However, shareholders of one of these smaller players could get an early Christmas, should Intel decide to simply purchase some existing expertise and market share in the mobile device segment of the chip market.

Today, we can profit today from Intel’s future colossal failure to go out of business, as it seems to be currently priced to do.  While you wait for the market to recognize its mistake and reward you with a substantial capital gain, you will also be able to enjoy the generous $0.90-per-share dividend, which provides a 4.3% yield.

KenMcG6150 owns shares and covered calls of Intel. The Motley Fool recommends Intel and NVIDIA. The Motley Fool owns shares of Intel and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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