There Is a 100% Upside in This Giant Chipmaker

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

The semiconductor industry continues to benefit immensely as the smartphone and tablets industries maintain their rapid growth. This growth is not as beneficial to every semiconductor company, however. Qualcomm (NASDAQ: QCOM), along with Advanced Micro Devices (NYSE: AMD), have definitely benefited from the increased sales in smart phones and tablets, but not so for Intel (NASDAQ: INTC), whose main customer is the PC industry, which continues to diminish. Intel is the world’s largest chipmaker, mainly due to its massive market share in PC microprocessor chips. The company has also ventured in the business of making mobile PC microprocessor chips, as it aims to compete against Qualcomm and AMD.

Intel’s smartphone chips could disrupt the market

Intel seems set to replicate its PC processor dominance in smartphones with its new Merrifield smartphone processor. According to the company’s press release, the 4th generation Intel Core processors serve as the foundation for a wave of new 2-in-1s that combine stunning PC performance with tablet-like mobility in one device and deliver on the Ultrabook vision. The chips are expected to reach consumers by 2014.

The company also recently launched an Intel Atom processor chip code-named Bay Trail for mobile devices which is expected to boost smartphone battery life for up to nine hours of crystal-clear video streaming. It seems as though Intel is out to stamp its authority in the chip-making business, reminding Qualcomm, AMD and ARM (NASDAQ: ARMH) that it is the father of processor chips.

With this kind of technology, Intel could easily change the way ARM, Qualcomm and AMD structure their chips. Soon, smartphone users will prioritize on long battery hours as the marginal rate of return on features continues to diminish. This will also put pressure on smartphone manufacturers to consider using processor chips that save battery power such as Intel’s Atom processor chip.

Intel could be staring at an opportunity for a massive growth in revenues due to sales from smartphone processor chips. This would also boost the company’s margins which otherwise remain impressive, but most importantly the company's earnings could grow by close to a third. Before the rest of the competition catch up with the new age smartphone chips, Intel would have already established a significant share of the market which could result in sustainable earnings growth rates.

Performance

Both Intel and Qualcomm reported declines in earnings for the most recent quarter year-over-year. Qualcomm’s earnings were down 16.3%, while Intel’s fell by 25.3%. ARM reported 38.8% surge in earnings, however, while AMD remained unprofitable. In terms of gross margins, ARM is the most impressive with 94%, as compared to Intel’s 60%, and Qualcomm’s 62%. AMD's gross margins are lowest at 34%. Intel’s 25% operating margin is not far off ARM’s 37%, though Qualcomm is even closer at 31%.

Nonetheless, Intel’s profitability can only be bettered by that of Qualcomm. ARM’s earnings per share (EPS) of $0.60 is well below Intel’s $2.00 and Qualcomm’s $3.56. AMD’s loss per share stands at $1.00. Note that fundamentally, AMD is the direct competitor to Intel while Qualcomm and ARM are indirect competitors. They are only competitive in various business lines such as the manufacture of mobile PC processor chips.

At the current price of $25.42 (as of June 19, at noon EDT), Intel trades at about 12.73 times its price-to earnings-ratio (P/E). The industry average is pegged at 61.99 times. The company’s estimated forward P/E for the year ending Dec. 29, 2014 is slightly below at 12.61. Its price-to-earnings growth ratio (PEG) for the next five years, which factors the projected earnings growth rate, is at 1.24 times; this is still below the industry average of 1.58.

Valuation

Based on the current P/E, Intel is nearly five times cheaper than the average company in the industry. The company’s recent development in smartphone processor chips also presents a huge upside in terms of earnings growth. Intel is at a turning point where the impact caused by the mobile wave is wearing out as the company introduces itself in style.

The previous projected earnings growth rate, which factored in recent declines, has been affected negatively. This could mean that the earnings growth rate may have been understated. Based on the PEG of 1.24, the current earnings growth rate for the next five years is roughly 20%. However, Intel still has the potential to grow earnings by at least 30% when its smartphones processor sales peak in 2014. This means that the company could be trading at well over $55 per share by 2015, which is more than 100% upside.

The bottom line

Intel’s balance sheet looks very healthy with an operating cash flow of more than $20 billion, against a debt of $13.35 billion. The company’s dividend yield of 3.50%, and a payout ratio of 44% is also very impressive and puts it among the best dividend payers.

Furthermore, Intel has already indicated its intention to capture a sizable market share as it seeks to capitalize on the world’s most promising market in the technology industry (the smartphones and tablets market.) This ensures that it remains relevant and competitive going forward. Finally, as revealed, Intel’s current price could be set to double in the next two to three years. In my opinion and assessment, is a very realistic target.

When it comes to dominating markets, it doesn't get much better than Intel's position in the PC microprocessor arena. However, that market is maturing, and Intel finds itself in a precarious situation longer term if it doesn't find new avenues for growth. In this premium research report on Intel, a Motley Fool analyst runs through all of the key topics investors should understand about the chip giant. Click here now to learn more.

 


Nicholas Kitonyi has no position in any stocks mentioned. The Motley Fool recommends Intel. 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!

blog comments powered by Disqus

Compare Brokers

Fool Disclosure