Stockwatch: overlooked and underpriced, a US tech giant to watch
8th February 2022 12:04
by Edmond Jackson from interactive investor
Heavy investment and an innovative new CEO could make this out-of-favour tech stock an attractive long-term buy, says our companies expert.
This week has commenced with presidents Xi and Putin agreeing a united stand on Taiwan and Nato – opposing Taiwanese independence and also expansion of the US-led security alliance in Europe. Let us hope a worst-case scenario of military action both in Taiwan and Ukraine, which would split the West’s attention, is averted.
Taiwan being cited in a Russia-China ‘alliance’ makes it pertinent to consider the West’s dependence on the island for microchip supplies. Outsourcing to the Far East has helped the Taiwan Semiconductor Manufacturing Company (NYSE:TSM) account for more than half of this global market. Together with United Microelectronics Corp (NYSE:UMC), Taiwan’s first semiconductor company set up in 1980, the country is the unmatched global leader in the industry.
A potential major beneficiary of chip disruption
The $196 billion (£145 billion) Intel Corporation (NASDAQ:INTC)manufactures its chips in the US, Ireland and Israel as well as China. Post-manufacture/assembly takes place in Malaysia, China, Costa Rica and Vietnam.
Part of the reason why its stock is relatively out of favour hinges on its heavy investment in further US capacity, weighing on earnings; but this will give Intel a unique strategic advantage should disruption occur in Taiwan.
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Such a worst-case scenario is not the base investment case for Intel, although it is interesting as a portfolio hedge as East/West tensions threaten to trigger military action.
Additionally, big-cap US tech stocks are generally overcooked. Yesterday, Alphabet (NASDAQ:GOOG), PayPal (NASDAQ:PYPL) and Meta Platforms (NASDAQ:FB) dropped 3% to 5%, and even feted leader Microsoft (NASDAQ:MSFT) slipped 2%. Intel, however, edged up 0.4%.
Big winners of recent years now look exposed as interest rates edge up, and if Intel sustains a relative outperformance then it could potentially help attract a sentiment shift after the company’s sideways consolidation since late 2017.
Relatively modest PE and material yield
At $48.18, Intel trades on a sub-10x trailing PE and is projected to return a 3% yield supported by around $30 billion annual operating cash flow. Yes, a modest PE and material yield reflect mixed operating performance; but an investment phase should help refresh a company that already looks well-positioned to exploit the next phase of technical device and internet development.
I hesitate to draw much parallel with Apple (NASDAQ:AAPL), but in May 2018 I did highlight the latter’s new product/service initiatives as justifying a long-term “buy” stance at around $44 equivalent (currently $172). While it is necessary to consider whether investment is needed simply to stay competitive, a sceptical perspective can mean organic growth potential is overlooked. In stock terms, refreshed growth is also likely to raise the PE rating.
Volatile trading during Covid’s tech-stock rally
In a long-term chart context, Intel shows a major roller-coaster from around $20 in 1998 to over $70 at the peak of the 2000 tech-stock boom, falling back below $20 after that bubble burst.
At the December 2008 trough of the great financial crisis, it dipped below $13, progressing to a recovery around $55 by March 2018; but it has since traded in a volatile sideways $44 to $68 range, most unlike the linear if not parabolic strength of US tech stocks since March 2020.
Intel did rally from $45 in November 2020 to $68 early last April, but has since slid back to the current $48 level, where it is now finding support.
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Mid-last year, the company reported broadly flat performance that began to edge up only in the third quarter, so unsurprisingly tech investors have sought greater excitement elsewhere.
As I explained last Friday, overcooked US tech valuations are exposed to a rising interest rate environment. I suggest that there is a fair chance that investor capital will switch back to Intel’s stock, so long as numbers do not fall short of guidance.
Gauging the impact of complex tech operations is so tricky that even specialist semiconductor analysts may not find it easy to call precise stock turns; but it is common sense to pay due regard to an investment period.
Lately, the market has taken the ‘glass half-empty’ view that this is going to compromise margins in the near term; but it supports Intel’s objective to accelerate long-term revenue growth to 10% to 12% annually in five years’ time.
There is a case for investing before sentiment potentially shifts to 'glass half-full’ in recognition of the earnings benefits to come, despite the timing challenge. I therefore suggest an averaging-in approach to Intel.
Intel Corporation 2021 results
Generally Accepted Accounting Principles
| Full year | Fourth quarter | |||||
| 2020 | 2021 | % change | 2020 | 2021 | % change | |
| Revenue - $ billion | 77.9 | 79.0 | 1.4% | 20.0 | 20.5 | 2.5% |
| Gross margin | 56.0% | 55.4% | -0.5 | 56.8% | 53.6% | -3.2 |
| R&D, marketing & admin costs - $ billion | 19.7 | 21.7 | 10% | 5.4 | 6.0 | 11% |
| Operating margin | 30.4% | 24.6% | -5.8 | 29.5% | 24.3% | -5.1 |
| Tax rate | 16.7% | 8.5% | -8.2 | 21.8% | 11.0% | -10.8 |
| Net income - $ billion | 20.9 | 19.9 | -5% | 5.9 | 4.6 | -21% |
| Earnings per share - $ | 4.94 | 4.86 | -2% | 1.42 | 1.13 | -21% |
Source: Intel financial results
Relatively new CEO with an engineering background
A series of CEOs who appeared to fail to overcome challenges as Intel’s historic market supplying PC chips declined in favour of mobile devices, helps to explain some of the loss of competitive advantage and investor interest.
As least a proven engineer is now in charge. Pat Gelsinger, previously Intel’s chief technology officer, returned to the company a year ago as CEO, having been CEO of $55 billion VMware Inc (NYSE:VMW).
Last March, he declared Intel Foundry Services as a base for manufacturing, innovation and product leadership, with $20 billion of investment in two new plants in Arizona and a similar amount to be spent on two more in Ohio. This will be a major factor in the evolution of Intel’s integrated device manufacturing.
Gelsinger proclaimed: “A new era of innovation and product leadership: Intel is the only company with the depth and breadth of software, silicon and platforms, packaging and process, that manufacturing customers can depend on for their next-generation innovations.”
His aim is for Intel to match and then surpass TSMC in 2025, although it will depend on the success of the current chip development cycle.
Intel is at least now well-positioned across all computing devices to unleash what Gelsinger calls “the four superpowers”: artificial intelligence, pervasive connectivity, cloud to edge, and ubiquitous computing. They sound pretty abstract, but “these capabilities…power the digitising of everything…and will exponentially increase the world’s need for computing.”
In 2021, Intel invested $15.2 billion in R&D, and also $18.7 billion in capital investments including extra manufacturing capacity. £30 billion cash was generated from operations, however, and there was $11.3 billion of free cash flow. The last three years’ cash flow profile, summarised on one page on Intel’s website, shows the company maintaining a strong cash flow profile, paying dividends and investing with only modest recourse to debt.
The stock’s fall over 2021 may relate to elevated capex for the next few years, possibly compromising this profile. It is helping Intel’s product story, though, with the current launch of 12th generation processors and also of Alchemist, a new line of graphics products.
Near-flat 2021 numbers yet attractive risk/reward
On 26 January, Intel declared $79 billion of revenue (see table), up by only 1.4% on the previous year because of supply constraints, although this improved to 2.5% in the fourth quarter. It was still the highest-ever annual revenue and it beat guidance for the fourth quarter chiefly due to momentum on Intel’s data centre side.
Annual earnings eased 2%, and net profit/EPS fell 21%. Sentiment was not helped by first-quarter 2022 guidance for a 1% slip in revenue and EPS down 40% year-on-year due to lower margins.
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But with the stock down at $48, I suggest Intel’s risk/reward profile is relatively attractive. For capital protection I would certainly rather hold Intel than a basket of FAANG stocks in a rising interest rate environment. It is speculative whether these ‘capable CEO’ and ‘accelerated investment’ considerations will achieve underlying progress. But there appear to be good reasons to follow Intel more closely, with a view to averaging in. Buy.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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