As of late, Intel (INTC) has been the Microsoft (MSFT) of the chip space. For example, the company beats estimates (in Q1 2011 by a lot), and then maybe moves up or down a percent or two. On its second-quarter earnings call, Intel announced that capital investments will total more than $10 billion for the year, and that PC growth was low double-digits rather than mid-double digits. The shares then experienced a mild sell-off.
However, the company continues to have a near monopoly in a growing sector and produces gobs of free cash flow. On a discounted cash flow valuation, we think Intel shares are worth $26 under a bear-case scenario, but $34 in our estimated scenario. However, given the market’s distaste for Intel, we think the shares should fetch a value of at least $26, which implies a P/E multiple of 11x our 2011 forecast. In the spirit of transparency, we make our DCF valuation model template available here.
The PC is dead…or is it?
Interestingly enough, a lot of the problems overhanging shares of Microsoft are creating an overhang on Intel. Much has been made about the rise of the tablet and the death of the PC. We think these worries are completely overblown. Although we love Apple (AAPL)–see our Best Ideas Newsletter–and think the tablet has considerable growth left, we don’t think it’s going to completely cannibalize the PC market. Additionally, according to most tech companies, the US is in the middle of a technology refresh cycle, which could accelerate if and when the macro situation improves.
Even if some companies abandon the Windows platform, Intel still supplies high margin processors to Apple. Admittedly, we’d be even more excited if Apple were using an Intel processor rather than its own A5, but we still think low-double digit PC growth will continue, as will the sales of Macs with Intel insides. In addition to PC growth, the build-out of the cloud will continue to be a tailwind for Intel. Data center processor revenue was up 14% in the second quarter, and the business has nearly doubled since 2009. We think companies building clouds will continue to trust Intel to power these clouds, and we could see data center processors becoming an even bigger part of the company’s revenue mix going forward.
More than just microchips
We also think the market has been quick to write-off Intel as little more than a parts supplier. With the acquisition of McAffe for $7.68 billion in 2010, Intel also entered the profitable software security and solutions industry. We expect McAffe to capitalize on the proliferation of corporate mobile devices and the downfall of Research in Motion’s (RIMM) Blackberry platform. McAffe should contribute at least another $2 billion to Intel’s top line in 2011. Clearly, analysts expected the bottom line contribution to be much greater than it was, as EPS growth was only 7.4% versus 21.1% top-line growth in the second quarter.
Though McAffe has stiff competition from free spyware and other security options on the consumer level, we think the enterprise business will continue to grow, and the results should eventually translate to increased profitability. In fact, Intel even forecasted that gross margins should increase by nearly 400 basis points to 64% in Q3. We think some of this can be attributed to the high-margin software business.
A clean balance sheet, healthy dividend make Intel a low-risk investment
With very little long-term debt, in fact so little that the company earns positive interest on the loads of cash it’s creating, we don’t think there’s much downside risk in Intel at $23 a share. It’s not a huge discount (12%) from our bear-case scenario, but we think the buybacks and healthy dividend (around 3.2%) should support the stock.
Even if the market fails to recognize the earning power and free cash flow of Intel, we think $26 is the lowest price investors should demand for their shares. This implies a trailing P/E multiple of 11 (which it currently trades at), and a dividend yield of 2.8%. However, if the market realizes that PCs aren’t dead and that Intel has diversified revenue streams, we think shares are worth as much as $34, giving investors a chance at nearly 50% upside.
