Valuentum Exclusive Analysis for the Discerning Investor

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Image Source: Intel Corporation – January 2020 Presentation

By Callum Turcan

In this article, we cover recent events in the semiconductor industry and how a bill that was just introduced in the US Congress could positively impact Intel Corporation (INTC). We include shares of INTC as a holding in both our Best Ideas Newsletter and Dividend Growth Newsletter portfolios and continue to like the company for numerous reasons that we will cover in this piece. Shares of INTC yield ~2.2% as of this writing.

Introducing the CHIPS for America Act

On June 10, a bipartisan group of US lawmakers introduced a bill that would support the existing domestic semiconductor manufacturing industry and encourage a new production facility to be built in the US. Currently, the bill is known as the Creating Helpful Incentives to Produce Semiconductors (‘CHIPS’) for America Act.

The approximately $22.8 billion bill includes ~$12.0 billion in additional R&D funding, ~$10.0 billion in federal funds for the purpose of matching state funds that are used to incentivize the construction of domestic production facilities and a 40% refundable tax credit for semiconductor manufacturing equipment (which would be reduced in stages and phased out in 2027 according to the WSJ). Also, the bill would create a ~$0.75 billion fund to help establish a consortium of foreign governments that would work together to promote transparency in the industry and attempt to align those nation’s policies as it relates to working with non-market oriented economies (i.e. statist economies run by a central authority, such as China).

The WSJ reports that some of the R&D funds would go towards an initiative by the Department of Defense to ensure the Pentagon has access to cutting-edge “chips” ($2.0 billion in funds within the bill are allocated to this initiative), another $5.0 billion would go towards general federal research, and another $5.0 billion would go towards supporting manufacturing activities that occur after the chips are made. 

Many of the proposals in this bill have long been sought after by the Semiconductor Industry Association (‘SIA’) which was founded in 1977 and represents the US semiconductor industry. Senator Cornyn (R, Texas) and Senator Warner (D, Virginia) introduced the bill in the US Senate on June 10 while Representative McCaul (R, Texas) and Representative Matsui (D, California) introduced a similar version of the bill in the US House of Representatives a day later.

This news comes on the heels of Taiwan Semiconductor Manufacturing Company Limited (TSM) announcing plans to build a new cutting edge semiconductor fabrication plant in Arizona back in May 2020. That plant will cost roughly $12.0 billion to build, and please note this fabrication plant is being built to produce semiconductors for third-parties.

As it relates to Intel, the company’s CEO Bob Swan sent a letter to the Pentagon back in late-April 2020 (according to the WSJ) expressing interest in building a semiconductor fabrication plant (possibly a fabrication plant that would be geared towards meeting third-party production needs) in the US in partnership with the Department of Defense. This bill could play a role in such a partnership, and/or additional legislation could be crafted in the future to support such a development.  

Intel already has very meaningful domestic production capabilities with semiconductor fabrication hubs in Hillsboro, Oregon (expansion activities are starting to get underway as Intel has noted it plans to build another semiconductor plant at its hub here), Chandler, Arizona (Intel relaunched a major ~$7.0 billion expansion program here back in 2017 that had previously gotten cancelled), and Rio Rancho, New Mexico (whether the firm has been growing its workforce in the recent past). Intel also has a significant presence in Hudson, Massachusetts, where it has an R&D hub. In fiscal 2019 (period ended December 28, 2019), Intel spent $13.4 billion on R&D expenses worldwide (on a GAAP basis).

Given Intel has been steadily bulking up its domestic production capabilities and plans to continue doing so, it appears the company is well-positioned to benefit from the CHIPS for American Act if passed. Other senators have signaled their support for the bill including Senator Risch (R, Idaho), Senator Rubio (R, Florida), and Senator Sinema (D, Arizona) by co-sponsoring the bill.

Looking at Intel

In the recent past, we have covered the ongoing US-China technological arms race and strongly encourage our members to read this article here if you have not already done so. The CHIPS for America Act is entirely about shoring up technology supply chains in the US in the face of rising tensions between the US and China. For Intel, the firm should benefit from the federal funds and tax credits that the bill would provide if enacted into law. Furthermore, should Intel team up with the Pentagon to build a semiconductor foundry in the US (to meet third-party needs as well as Intel’s), that could provide for additional upside.

This news is entirely incremental to our discounted free cash flow model valuing Intel. We include Intel as a top-weighted holding in our Dividend Growth Newsletter portfolio because we like its stellar cash flow profile and strong liquidity levels. Our Dividend Cushion ratio sits at 2.1, providing for a “GOOD” Dividend Safety rating. Please note these are forward-looking and our enterprise cash flow models factor in our expectation that Intel will push through high-single-digit per share annual payout growth over the coming years. We give Intel an “EXCELLENT” Dividend Growth rating.

Intel is also included as a moderate-weighted holding in our Best Ideas Newsletter portfolio because we like its capital appreciation potential. The company’s ability to capitalize on secular growth tailwinds and its resilience in the face of the ongoing coronavirus (‘COVID-19’) pandemic on both a financial and operational basis highlights why we like the firm.

Covering Intel’s Financials

At the end of its first quarter of fiscal 2020 (period ended March 28, 2020), Intel carried $20.8 billion in cash and cash equivalents, short-term investments, and trading assets on the books along with $3.9 billion in equity investments (that consisted primarily of marketable and non-marketable equity securities) and $2.9 billion in other long-term assets (that consisted primarily of corporate debt, financial institution debt, and government debt).

That was stacked up against $3.5 billion in short-term debt and $36.5 billion in long-term debt. Though Intel carries a net debt load we view that as very manageable given its extensive cash and cash-like assets on hand. Intel raised a significant amount of money in debt markets at attractive rates back in February 2020 by issuing long-term senior notes with staggered maturities, highlighting its ability to tap capital markets as needed.

The company generated $2.9 billion in free cash flow in the fiscal first quarter which fully covered $1.5 billion in dividend payments, though $4.2 billion in share repurchases were funded in part by the balance sheet. Intel has since suspended its share buyback program (announced back in March 2020) in the wake of the pandemic. Additionally, Intel noted it would remain committed to its current dividend policy. Here’s what Intel had to say in its March 24 8-K filing (emphasis added):

On March 24, 2020, Intel Corporation (“Intel”) announced that it is suspending stock repurchases in light of the COVID-19 pandemic. To date, Intel has kept its factories operational while safeguarding the health and safety of employees and continues to have a strong balance sheet. Intel’s management believes the suspension, while conservative, is prudent given uncertainty regarding the length and severity of the pandemic.

The suspension of stock repurchases will not impact dividend payments to stockholders and the company has the ability to reinstate repurchases as circumstances warrant. In October 2019, Intel announced its intention to repurchase $20 billion in shares over the next 15 to 18 months. Intel has repurchased a total of approximately $7.6 billion in shares in the fourth quarter of 2019 and first quarter of 2020, prior to the suspension.

Additionally, during Intel’s first quarter of fiscal 2020 conference call, management reiterated the company’s commitment to its dividend. Intel’s management also stated that the company was still committed to completing the $20.0 billion share repurchase program once “dynamics stabilize[d].” Management wants to preserve Intel’s financial position until the pandemic subsides which is a prudent decision, in our view. When Intel reported its first quarter of fiscal 2020 earnings report, the firm had reduced its weighted-average outstanding diluted share count by almost 6% year-over-year via aggressive share repurchases.

Monitoring Intel’s Operational Performance

Intel’s operations appeared to have continued functioning properly and near full capacity in the face of COVID-19. Some expansion activities were temporarily delayed, but not in a significant way according to Intel. Management had this to say during Intel’s latest quarterly conference call (emphasis added):

“Our world-class safety standards have allowed our factories to continue to operate safely on a relatively normal basis with greater than 90% on-time delivery. We only allow employees in our factories who are essential to the factories’ operations. By design, our clean rooms and factories are among the cleanest places in the world.

While most of our construction projects have remained operational, we have had to temporarily pause a few projects due to local government restrictions at a small number of our sites. We will restart those projects in due course, and we expect these interruptions to have minimal impact on our ramp and no impact on our process technology transition time line.” – Bob Swan, CEO of Intel

Since reporting its fiscal first quarter earnings, Intel has not released (as of this writing) another press release or published an 8-K filing indicating things have changed in a significant manner. During Intel’s fiscal 2020 annual stockholders meeting which was held on May 14, the company published a Q&A sheet answering questions management was not able to answer during the meeting providing an update on Intel’s affairs. Here are some key excerpts from the Q&A sheet (emphasis added):

First, we will address enterprise risk management. Throughout this evolving situation, Intel has managed to continue operating its manufacturing, assembly, test and supply chain operations in Oregon, New Mexico, California and Arizona as well as in Israel, Ireland, China, Malaysia, Vietnam and other Intel and partner locations around the world. In fact, the company was able to maintain a greater than 90% on-time delivery rate. This required close coordination and cooperation with suppliers as well as with local and national governments to help ensure worker safety while allowing critical operations to continue…

The second point is financial implications. And in light of the uncertainty, we took some very specific actions to dramatically strengthen our liquidity position that we felt were prudent. We raised $10.3 billion in debt to further underpin our already strong balance sheet [this was primarily done in February 2020 as mentioned previously], and we suspended share buybacks. We think this level of conservatism is appropriate at this phase, and we intend to reinstate our buyback program as circumstances warrant. Our focus now is on investing in our products and process technology and ensuring that we have the capacity to meet our customers' needs.

It appears Intel’s operations have continued to function near full capacity during the first phase of the pandemic, allowing the firm to meet the needs of its customers. A recent WSJ piece highlighted how Intel used augmented reality (‘AR’) to conduct crucial maintenance and repairs during the pandemic. The article highlighted how in March 2020, Intel needed to perform work at its manufacturing hub in Chandler but the engineer who would normally do that work was stuck in Germany due to COVID-19 containment efforts. AR goggles allowed the engineer to relay the necessary information to Intel’s employees in Arizona to get the work done, allowing manufacturing activities to resume. We appreciate Intel’s resourcefulness.

Looking Ahead

When Intel reports its fiscal second quarter earnings, we will get a better look at its financial and operational performance. Though the earnings report might be brutal, we are more interested in how Intel expects its financial performance will hold up going forward. As the US economy and global economy at-large have started to reopen, the firm’s near-term outlook appears to have improved significantly in recent weeks.

Within its fiscal first quarter earnings report, Intel provided guidance for the fiscal second quarter, though please keep in mind predicting financial performance during a pandemic is no easy task. Intel forecasted on a GAAP basis it would generate $18.5 billion in revenues and carry an operating margin of 28% during the period. On a non-GAAP basis, Intel forecasted it would generate $18.5+ billion in revenues and carry an operating margin of 30% in the quarter. For reference, Intel generated $19.8 billion in GAAP revenue and carried a GAAP operating margin of 35.5% in the first quarter of fiscal 2020. For comparison purposes, in the second quarter of fiscal 2019 (period ended June 29, 2019), Intel generated $16.5 billion in GAAP revenues and carried a GAAP operating margin of 28%.

It appears Intel (on a GAAP basis) is guiding for nice year-over-year growth in its revenues this fiscal quarter, and for its operating margin to stay broadly flat. Strength at its ‘Data Center’ segment will be key, as that segment saw its revenues rise by 43% last fiscal quarter on a year-over-year basis. In the first quarter of fiscal 2020, Intel’s Data Center segment generated $7.0 billion in sales and segment-level operating income of $3.5 billion. 

During Intel’s latest quarterly conference call, management noted that demand from cloud-related customers was quite strong in the fiscal first quarter and was expected to remain strong in the fiscal second quarter. While demand from government-related entities and certain enterprises was expected to soften (in the near term), strength from the cloud computing space could lend material support to Intel’s near-term financials going forward (as has been the case in the recent past).

Concluding Thoughts

Things are looking up for Intel, relating speaking, and we continue to like shares of INTC as a holding in both our Best Ideas Newsletter and Dividend Growth Newsletter portfolios. When Intel reports its fiscal second quarter results and provides investors with an update on how its operations and financials have performed during the worst of the first phase of the COVID-19 pandemic (particularly for Europe and North America), we will have much more to say on the name.

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Broad Line Semiconductor Industry – AMD AVGO FSLR INTC TXN

Communications Equipment Industry – CSCO JNPR KN NOK SMCI

Integrated Circuits Industry – ADI MCHP MRVL NVDA SWKS TSM XLNX

Semiconductor Equipment Industry – AMAT CREE IPGP KLAC LRCX MKSI SNPS TER

Related: ASML, CAJ, NINOY, SMICY, SSNLF, TRMC, TSM

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Callum Turcan does not own shares in any of the securities mentioned above. Cisco Systems Inc (CSCO) and Intel Corporation (INTC) are both included in both Valuentum’s simulated Best Ideas Newsletter and Dividend Growth Newsletter portfolios. Some of the other companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.