Intel’s (INTC) third-quarter results, released October 14, didn’t turn many heads, but the company did beat expectations on both the top and bottom lines, performance that was well-received by the market. Revenue generated in the quarter was approximately flat on a year-over-year basis, but the mark did beat the consensus estimate by $250 million. The chip giant’s earnings of $0.64 per share in the quarter exceeded expectations by a nickel per share. It wasn’t a bad showing by any stretch of the imagination, but Intel continues to feel the pain of a shrinking personal computing market, even as optimism flies high with respect to the firm’s 6th Gen Intel Core processors.
Revenue from Intel’s Data Center Group, which includes server, network, and storage platforms, and its Internet of Things Group, which includes platforms for embedded market segments, advanced 7% and 12% on a year-over-year basis during the quarter, respectively. Headwinds impacting its larger Client Computing Group (now the combination of its PC Client Group and Mobile and Communications Group), however, drove sales in that segment down 7% on a year-over-year basis. In the quarter, notebook-platform volume fell 14%, while desktop-platform volume was even worse, down 15% on a year-over-year basis. Tablet-related volumes plummeted nearly 40% in the period. However, pricing has held up fairly well in notebook- and desktop-related applications (up 4% and 8%, respectively), and this means Intel’s widely-watched gross margin will remain resilient.
Part of the reason why we like Intel is that many continue to dismiss the firm’s entrance into the mobile market, an area traditionally dominated by Qualcomm (QCOM). It is widely-accepted that Intel’s research and development prowess has nearly put AMD (AMD) out of business, and we’re confident the chip giant’s resources and innovation track record will open the door to the mobile market in a big way. In March, it was reported that Intel’s technology will find its way into Apple’s (AAPL) smartphones, and the runway with the iPhone giant is very long. Some estimates suggest that “Intel may capture half of all modem chips powering the upcoming iPhones, which could amount to as much as $1.25 billion in additional revenue.” We’re expecting 2016 to be a break-out year for Intel, as investors begin to factor in an even more promising 2017, in our view. The Microsoft (MSFT) Windows 10 PC upgrade may end up just being icing on the cake if Intel’s work with Apple flourishes.
We’re expecting Intel’s pending acquisition of Altera (ALTR) to be a source of upside, as it, too, serves to reignite the chip giant’s growth engines. Altera is simply a cash cow, having generated nearly $700 million in cash flow from operations on capital spending of about $40-$60 million in 2014, and we like the company’s dominance in field-programmable gate arrays, FPGAs, a subsegment of programmable logic devices (PLDs) that have much better economics than either ASICs or ASPPs and are poised to displace legacy technologies. Intel’s decision to scoop up Altera is a great one, in our view:
By most estimates, the ASIC and ASSP replacement opportunity alone offers growth that’s twice as fast as the overall semiconductor industry, something Intel wants, and Altera brings to the table a complete FPGA portfolio (Generation 10), from the Max 10 (refresh CPLD/low-end) to the Arria 10 (mid-range markets), and the Stratix 10 on the high end. Altera estimates that the PLD (FPGA) market was nearly $5 billion in 2014, but the combined portion of the ASIC and ASSP markets that was accessible for PLD displacement was over $50 billion, revealing the tremendous growth potential of PLDs (FPGAs). Altera’s Stratix Series already cooperates with Intel 14nm Tri-Gate technology, offering customers double the performance gains in most cases. In a recent Intel presentation, the tech behemoth showcased the significant cost per transistor savings in its 14bnm TriGate technology. The new HyperFlex core fabric architecture results in a level of performance and power efficiency that is unmatched by any existing FPGA architecture, according to the firm.
We like Altera’s competitive position to win new business and its existing partnership with Intel, which should smooth deal integration. In fact, Altera’s management will tell you that its partnership with Intel has given it an upper hand in addressing performance, power consumption, and cost at the same time, while rivals have struggled with each sequentially. From what we can tell, this has given Altera an early-mover advantage, even relative to its chief FPGA rival Xilinx (XLNX), and the growing “process technology gap” for new designs between PLDs (FPGAs) and the ASIC alternative is revealing. Even if Altera doesn’t sustain such an advantage relative to technology-savvy peers, the benefits of FPGAs over ASICs should generate a market large enough for a number of players.
Intel has recently issued incremental debt to help finance the deal with Altera, and we have taken note that its balance sheet is not as attractive as it once was. Cash, short-term investments, and trading assets total $20.8 billion, but short- and long-term debt now stand at $21.1 billion. Though Intel’s balance sheet isn’t as cash-rich as that of other tech giants, including Apple and Microsoft, the firm generates cash from operations like few others. During the third quarter, for example, Intel hauled in $5.7 billion in cash from operations and spent $1.2 billion in additions to property, plant and equipment–good for $4.5 billion in free cash flow, over 30% of quarterly revenue. Prudent management of capital spending will continue to buoy free cash flow available for buybacks and dividends, the latter poised for significant long-term expansion, in our view.
We value shares of Intel at $38 each, but we think a trip to the mid-$40s on the basis of the high end of our fair value range may be in the cards should 2016 come in better than we’re expecting, a distinct possibility. Shares currently register a rating of a 9 on the Valuentum Buying Index, and the chip giant remains a core holding in both the Best Ideas Newsletter and Dividend Growth Newsletter portfolios. A dividend yield of ~3% and a Dividend Cushion ratio of 2.5 makes Intel one of our favorite ideas on the market today!