Why You Should Sell TI, Buy Intel
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Bullish about tablets, software, and smartphones; but exhausted about the amount of choices? Semiconductors are one of the easiest ways to diversify across technology, since they essentially form the "infrastructure" of the latest gizmo. In my view, Intel (NASDAQ: INTC) is currently undervalued whereas Texas Instruments (NASDAQ:TXN) is not. Below, I review the fundamentals of both companies.
Intel trades at a respective 10.5x and 9.8x past and forward earnings while offering a dividend yield of 3.6%. To put that into perspective, consider that the firm's historical 5-year average PE multiple is 17.7x. Thus, not only is the upside substantial from margins expansion, but the downside is relatively limited from management's shareholder-friendly capital allocation policy.
Profit margins have meanwhile seen a steady improvement from the 16% range between 1Q08 - 2Q08 to the 21% range between 1Q12 - 2Q12. Analysts forecast EPS growing by just 10.7% annually over the next 5 years - less than half of what was achieved over the preceding 5 years. In any event, this implies a future valuation of $51.74 at a 15x multiple - a multiple that is meaningfully below the 17.7x 5-year average. Discounting backwards by 8% yields a present value of $35.21, which implies that Intel is trading at around a 45% discount to intrinsic value.
The $124B company is also a free cash flow machine. FCF for the TTM ending 2Q12 was $9.5B versus $8.7B in 2Q11. At the same time, the company continues to increase its R&D expenditures, which will help sustain the company's brand strength in innovation. I recommend buying shares, because the margin of safety is high, supported by a strong dividend yield, and the growth opportunities are excellent.
TI is considerably more expensive than Intel at 13.5x, and it doesn't even offer a higher dividend yield. The current dividend yield is around 130 bps lower than Intel's while volatility is around the same to slightly more. Analysts are equally neutral on both stocks - rating them a 2.4 out of 5 where 1 is a "buy" according to FINVIZ.com.
What makes me concerned about TI is that investors will start to look towards higher-growth peers as a justification for lower multiples. Analysts forecast 9% annual EPS growth over the next 5 years, which is pretty optimistic considering that annual EPS growth was just 2.6% over the preceding 5 years.
Could TI disappoint? Well, all 5 of the last 5 quarters have beat expectations by an average of nearly 8%. Consensus EPS estimates have nevertheless gone down from $2.36 90 days ago to $2.08 today - a more than 10% decline. Earnings growth has lagged the industry by nearly 400 bps over the last 5 years while 2012 performance has been several folds worse and future expectations 20 bps less. Accordingly, I recommend selling shares and buying competitors to profit off of the correction to multiples.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Intel. Motley Fool newsletter services recommend Intel. 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.If you have questions about this post or the Fool’s blog network, click here for information.