PRACTICAL STOCK INVESTING

the report

4Q11

After the close of trading in New York on Thursday January 19th, INTC reported 4Q11 results.  Revenues came in at $13.9 billion.  Profits were $3.4 billion, eps $.64.  Both figures were down slightly quarter on quarter during what’s normally the company’s seasonally strongest period.  Eps surpassed the Wall Street consensus of $.61, though.  Wall Street’s habitually somewhat downbeat stance toward INTC was certainly influenced by the firm’s early December warning that near-term orders for its PC chips were being cancelled by device manufacturers who are unable to get enough hard disk drives to make new PCs.

On a non-GAAP basis (adjusting for acquisition-related goodwill),  eps came in at $.68.

Investors were pleased with the results.  INTC shares rose by about 3% in a flat market on Friday.

full year 2011

During 2011, INTC achieved lots of all-time financial highs, including:  revenues at $54 billion; net income at $12.9 billion; eps at $2.39 (non-GAAP, $2.53).

one-time factors

There are two:

–Historically, INTC has used the week as the basic time period for its accounts rather than the month.  Because  52 weeks x 7 days/week = 364 days, or not quite a year, this approach requires the company to have occasional 53-week years to keep their accounting in sync with the calendar.  2011 was one of those “extra-week” years.  That probably added $.05 to 2011 eps.

(By the way, INTC has just shifted to the month as its basic time measure, so the “extra week” adjustment will no longer be necessary.)

–Thailand produces about 40% of the world’s hard disk drives. Massive flooding there during 4Q11 took many HDD factories out of commission.  In early December, unable to build PCs without storage, device makers began to cancel orders for the INTC chips slated to go into those machines.   INTC thinks we’re now passing the worst of the HDD shortage and that Thailand will be back at full HDD production late in 2Q12.  INTC is adamant that component supply, not a falloff in demand, is the problem.  Assuming the company is correct–and I see no reason to doubt it–the result of the cancellations has probably been to shift $.10 – $.15 a share in earnings for INTC from 2011 into 2012, as well as to make the firm’s 2o12 eps more second-half loaded than normal.

prospects for 2012

INTC expects another up year in 2012, with revenues advancing by “high single digits” and gross margins expanding by 1.5 percentage points to around 64%.  Despite a massive increase in R&D spending to $10.1 billion this year (up by 21% from the 2011 level) this company guidance probably implies eps on a GAAP basis of $2.60 ($2.75, non-GAAP).  If we correct for the one-time factors I’ve cited above, I read the guidance as being for flattish eps on, say, 5% revenue growth.

my thoughts

down Memory Lane

At the peak of the internet bubble in 2002, INTC was a $75 stock.  It traded at 36x eps (a relative multiple of 2.4x the market) and yielded .1%.  After a decade of wretched relative performance, the stock is now trading at less than 10x 2012 earnings, yielding 3.4% and at a price earnings multiple discount to the market of about 25%.

If you think that’s bad, in early October 2011 INTC was trading at 7.3x 2012 eps and yielding 4%+, more than the 30-year Treasury!  Interestingly, despite Wall Street skepticism, INTC shares are enjoying their longest period (and one of only a few) of relative strength in the last decade.

where to from here?  (I wrote this on Sunday January 21st)

I think there are four potential positive points to the INTC story:

1. valuation.   …low PE, high dividend yield, massively cash generative operations

2.   demand for PCs.   …that emerging markets have reached wealth levels where average citizens are able to afford PCs.  According to INTC, two-thirds of PCs worldwide are currently being sold to customers in emerging economies.  None of these markets are as yet well-penetrated.   So this business, INTC’s biggest by unit volume, appears to me to have much better growth prospects than is commonly thought.  Ultrabooks, using reference designs supplied by INTC, may well be an added plus.

3.  servers/the cloud.   …the continuing evolution of the internet is creating strong demand both for the INTC chips that drive sophisticated servers for the cloud and for those used for general corporate purposes.  These tend to be advanced (read: expensive and high-margin) chips.

4.  INTC’s immense technology investments.     …in 2012, INTC plans capital expenditures of $12.5 billion, in addition to R&D outlays of $10.1 billion.  In 2011, those figures were $10.8 billion for capex and $8.3 billion on R&D.  The two-year total comes to $41.7 billion!

Three possible consequences:

–increasing INTC’s already large technological lead over other manufacturers

–creating chips that will be accepted by makers of cellphones and tablets.  For instance, Lenovo has announced its first INTC-powered smartphone for the mainland Chinese market.

–creating an environment for collaboration on design of increasingly complex multi-function chips, either with independent design firms or with device manufacturers.  In other words, INTC would use its advanced chip fabs to attract and lock in customers.     …like AAPL?

It seems to me that at $20 a share, Wall Street was factoring into the INTC stock price a belief that:

–none of its turnaround efforts would be successful,

–that the parlous state of the PC market in the US and Europe is indicative of the global market for these devices,

–that INTC parts will be displaced by ARMH components, and therefore

–that INTC will gradually go out of business.

the stock

To buy the stock at $20 a share, you’d only have to believe that stories of INTC’s demise have been greatly exaggerated.

At the current $26 or so, in contrast, it seems to me the price already factors in a grudging acceptance that the PC business may not be on its deathbed.  I don’t think, however, that the value of the server business is fully reflected.  Nor is there anything, in my view, for the possibility that ultrabooks may expand the PC category or that INTC will have any success cracking the smartphone or tablet market.  Wall Street analysts are merrily downgrading the stock, meaning they don’t want to be seen as endorsing any of these possibilities.

$30 a share seems to me to be the next price objective.  At that level, I think the idea that the current business, PCs and servers, is viable would be in the quote.  But I don’t think there would be very much for new products.  In addition, I don’t think that very many have considered the thought that, after more than a decade of foundry success, the economic winds may be shifting in favor of integrated design/manufacturing firms like INTC or Samsung.

My bottom line:  INTC is no longer the one-way street it was in October, but I think it still has very attractive prospects.  I have no desire to sell any of the stock I own.  On the other hand, given the strong run it has made over the past four months, the size of my holding, and the possibility that good news probably won’t arrive before 2H12 begins, I don’t feel a powerful urge to buy today.  I do think the stock will outperform the S&P over the coming year, though.