Intel Ready For Tougher Q3
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Intel (NASDAQ: INTC) recently reported 2nd quarter earnings ahead of analysts' estimates. Intel's 2nd quarter revenues increased by 5% from the previous quarter to $13.5 billion, missing some analysts' estimates of $13.56 billion for the quarter. Earnings per share beat expectations at $0.54 per share, ahead of earlier estimates of $0.52 per share. Intel's stock price has seen double digit decreases over the past 90 days, perhaps due to expectations of a rough 3rd quarter ahead. The company has not shied away from this news, citing a challenging microeconomic environment. Intel has historically held a very strong relationship with Microsoft (NASDAQ: MSFT) by supporting the Windows operating system. The company currently holds 70% of the desktop market but is facing increasing pressures from smaller competitors. Microsoft announced on June 18th that it was launching two versions of its new touch-enabled tablet computer, the Surface. One version will run on Windows 8 and uses an Intel chip. The other version, which will run on Windows RT, will use Nvidia's (NASDAQ: NVDA) chip which is based on ARM Holdings' (NASDAQ: ARMH) processor design. The Surface was designed to compete head-to-head with Apple's (NASDAQ: AAPL) iPad, and the RT version, which uses Nvidia's chip, happens to be lighter and slimmer than its Windows 8 cousin.
Intel announced on July 9th that it is purchasing a $3.1 billion share of ASML Holding, N.V. This investment allows the company to partner with the semiconductor giant to develop the next generation in chip technology. Intel is already a giant of a company with a market cap of $128 billion; the company shows no signs of slowing growth and has a massive R&D budget to fund new technologies. This joint venture is expected to further enhance Intel's already sizable technology portfolio and expand on both firms' R&D expertise. Intel has also promised to invest $1 billion of R&D with ASML to develop these next generation chips. Slightly over one-third of the $1 billion R&D budget will be used to develop EUV lithograph technology. The EUV technology allows chip manufacturers to pack more integrated circuits on an ever-smaller wafer, which is not possible with current technology.
Intel is currently the world's largest chip maker, although there are two smaller competitors, namely Advanced Micro Devices (AMD) and ARM Holdings that are vying for market share. AMD and ARM are increasingly competitive in technologies that require extremely small, low-energy high-performance chips, such as smartphones and tablet computers. Now, a third manufacturer, Nvidia, is chipping away at Intel's long standing relationship with major tech companies, i.e. Microsoft. Intel must continue to innovate and leverage its research budget (or partner with other world-class firms), which will be the key to Intel's ability to maintain its status as a growth stock. I believe Intel will continue to invest heavily in R&D, as the past two quarterly financial reports show that the company has increased its R&D spending as revenue has increased. Recently, R&D spending was 18.6% of quarterly revenue.
Interestingly, AMD recently announced that its 2nd quarter revenues would come in under the previous forecast and would decrease 11% from the previous quarter. The decline in sales is partially due to weak channel sales in China and Europe and weaker Original Equipment Manufacturer (OEM) sales domestically. While AMD is a fraction of Intel's size, the company has cleverly focused its own efforts on HD video cards and super-thin chips that run tablet computers and ultrabooks. AMD has a new energy efficient platform called Brazos, which can support Windows 7 and Android systems in tablet computers. AMD announced in late June that it was launching the world's fastest Graphic Processing Unit (GPU), which will support cutting-edge graphics for computer games and digital video content. Earlier versions of this technology were well received by gamers who run graphic intensive games that require a lot of memory. AMD also launched a new series of chips designed specifically for super-thin and light laptops, similar to Intel's ultrabooks and significantly less expensive than Intel's comparable chip.
Microsoft's new Surface table computer is good news for ARM Holdings, which designed the chip architecture used by the chip manufacturer Nvidia. ARM does not manufacturer chips but licenses its technologies, used in popular mobile devices that run Apple iOS and Google's (GOOG) Android operating system. Apple's iPhone and iPad and Samsung (SSNLF) Galaxy Tab, which runs on Android, all use ARM's architecture.
I am not significantly changing my estimate of Intel's equity value. In the past, I used two approaches, a dividend discount model and a relative value analysis, and I still favor these two methods for this stock. Intel's current dividend is $0.84 cents per share, which implies a dividend yield of about 3.30%. This is equal to a payout ratio of approximately 20% of operating cash flow and results in a value of $28 per share.
Intel currently trades at roughly a 10.74 times price-to-earnings ratio, which is slightly higher than in my last review of this stock. Intel stock has decreased from a high of $29.18 over the past 90 days to a recent price around $25. This reflects a decrease of 13% in the stock price over a very short time period. Assuming Intel would trade at a similar PE multiple as the S&P 500, a multiple of 14, which I used in my previous estimates, still seems like a fair proxy and, when based on 2011 earnings, translates into a $33 per share value. In my previous analysis, I calculated a $34 valuation, which I felt was an expensive entry point, especially for a value investor. I still feel comfortable purchasing Intel at a 20% margin of safety to the $28 price estimate, which translates to a target purchase price of $22.40.
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