Intel (INTC) reported earnings at the close of trading Thursday, and we could not help but write about the struggling tech bellwether. There is no doubt that it was a rough quarter for the embattled chip maker, as they warned twice during the quarter of flagging sales. But the bar had been set so low, that it creates a real opportunity for value-minded investors. Perhaps rightly the stock took a beating of 36% in the last six months, and the actual quarterly results were just as bad as Intel had warned. Profits slid 90% to just 4 cents as the revenue dropped 23% versus last year and 20% from just last quarter. Gross margin was also a concern as it came in at just 53.1%, on the low end of expectations. However, our contention is that at these prices, Intel is a stock that is worth owning even as the company’s current operations look bleak.
It is always a wise strategy in recessions to invest in things that the world needs, and even though demand is down right now, the world will continue to need computers. Computing technology becomes obsolete very quickly, and right now as sales are slumping innovators like Intel are improving computing capabilities. Computers run on microprocessors and Intel is not just the leader in that field, they dominate it, with more than 80% of market share. That is greater market share than Google (GOOG) for search and approaches the market share that Microsoft’s (MSFT) Windows claims. It is clear that both business and personal computer buyers prefer the Intel chips to those of their primary competitor Advanced Micro Devices (AMD). Chief Executive Officer Paul Otellini said:
“The economy and the industry are in the process of resetting to a new baseline from which growth will resume. Our new technologies and new products will help us ignite market growth and thrive when the economy recovers.”
Intel has the microprocessor market covered with a range of products. They make the fastest chip in the industry which sells for $1000, which of course is only for a select group of consumers. On the contrary, they also make the most basic and inexpensive of chips for the growing market for “netbooks” that sell for just a few hundred dollars for the entire computer. We profiled Intel’s leap into the netbook market in our blog (Intel Brings Personal Computing to Billions). The emergence of netbook computers has some investors scared of the compression in profit margins for these cheap machines. However, the way people use computers is changing, as witnessed among other trends, people now love using their phones as a mobile computer with constant access to email and the web. Many consumers are likewise enjoying the simplicity of the netbooks which are functional for many of the more basic operations of computers. For Intel, we believe that it is better to be on the forefront of this change than lagging behind and trying to catch up. Businesses and certain people will always need capabilities that can only be accomplished by full/powerful computers, but many consumers will opt for the cheaper option to meet basic computing needs. Intel seems to have both market segments covered, as they are responding appropriately to a changing consumer.
Aside from being one of the predominate names in the entire tech industry, Intel has a tradition of remaining profitable even in tough environments. The company does face significant challenges in the coming months, and they are likely to need to reduce staffing and other overhead costs in order to meet these demanding times. The company cut operating costs by 11% in the last quarter in preparation of a difficult environment. As of this quarterly report, Intel did not announce any job cuts but they are not hiring either.
Keeping things in perspective, Intel’s business has slowed significantly but the company is now trading at levels not even seen in the wake of the Tech bubble lows in 2002. Since the Tech crash, Intel has been range bound between the high teens and the low thirties. You have to look all the way back to 1996 to find Intel trading at this price level, of course adjusted for splits. Furthermore, Intel is yielding an attractive 4% these days, and has consistently increased dividends for the last 16 years. So, even with no appreciation the income portion looks compelling.
We, at Ockham, see this stock as Undervalued as of our most current report. Even as sales have slipped in the most recent quarter, the stock is trading far outside of its normal price-to-sales range. The market has historically been willing to pay 2.42x to 4.54x on a price-to-sales basis, but currently that measure is only 1.9x. Cash earnings are a similar story as Intel is trading a full 45% below the average price-to-cash earnings as calculated by our methodology. Intel may indeed fall a bit lower, but they will continue to be the dominate chip maker, making the brains for most of the world’s PCs. The exceptional yield is enough to make us think that the wait for business to pick up will be worth it, and then investors will have their patience rewarded as the stock climbs back to more normal valuations as businesses and consumers get the itch to spend again.