Thursday, January 14th, 2010 - Intel (INTC, Financial) reports “Fourth-Quarter Net Income $2.3 billion, up 875%”. That headline compares the last 3 months of 2009 with the last 3 months of 2008 - a financial panic. The full year comparison isn’t as impressive:
· Sales down 7%
· Operating Income down 6%
· Net Income up 12%
· And Earnings Per Share up 14%
Those are short term numbers. Here are Intel’s long term numbers:
Intel’s Yearly Sales Growth
1987-1994: 29.28%
1994-2001: 13.21%
2001-2008: 3.54%
I used 3 year averages to avoid measuring from the top or bottom of a business cycle. So the 1987-1994 growth rate is really the difference between Intel’s average sales for 1986, 1987, and 1988 and its average sales of 1993, 1994, and 1995.
Intel’s sales have been slowing for decades. That’s normal. The bigger a business gets the slower it grows. Few businesses will grow as fast over the next 10 years as they did over the last 10 years.
From 1999 to 2009 Intel’s sales went from $29.39 billion to $35.13 billion - growing 1.80% a year. That’s much slower than the American economy. Intel’s $29.39 billion in 1999 dollars is worth $37.77 billion in 2009 dollars - Intel had sales of just $35.13 billion.
In its best year - 2007 - Intel had sales of $38.33 billion. Even that is barely better than 1999 when adjusted for inflation.
Intel’s Investment in the Future
Part of the problem for Intel investors is the company’s heavy investments in its future. Intel is straightforward about this:
“We are committed to investing in world-class technology…Our R&D (Research and Development) activities are directed toward developing the technology innovations that we believe will deliver our next generation of products and platforms…we plan to introduce a new microarchitecture for our…processors approximately every two years and ramp the next generation of silicon process technology in the intervening year.”
That’s great news for the world. And good news for Intel’s position relative to its competitors. But it’s not necessarily good news for Intel’s shareholders.
Despite growing slower Intel has been investing more in its business.
The most important investments Intel makes are in research and capital spending. Adding these two numbers together gives us a combined “investment” number we can use to see how much Intel is spending on its progress.
Not surprisingly Intel is investing more per dollar of sales in research and capital spending than it did 10 years ago:
· From 1996-1998 Intel spent 24.19% of sales on R&D and cap-Ex combined.
· From 2006-2008 Intel spent 30.01% of sales on R&D and Cap-Ex combined.
This isn’t surprising because Intel’s sales haven’t grown much in inflation adjusted terms. It’s hard to keep costs steady even when sales aren’t growing. Most businesses’s margins and returns on capital drop when sales stand still because expenses grow even when sales don’t.
The big surprise at Intel is that combined investment in research and capital spending has grown relative to assets:
· From 1996-1998 Intel spent 19.91% of tangible assets on R&D and Cap-Ex each year.
· From 2006-2008 Intel spent 23.44% of tangible assets on R&D and Cap-Ex each year.
This suggests the competitive lifespan of Intel’s assets is shorter than it was 10 years ago. That’s not necessarily a bad thing. In fact it’s part of Intel’s strategy to force the pace of technological process.
Normally a slow-growth or no-growth business increases the competitive lifespan of its assets and decreases spending meant to maintain its competitive position - like research and capital spending.
Intel is investing more relative to assets and sales than it did 10 years ago while growing less. That suggests Intel’s return on its research and capital spending is a lot lower than it was 10 years ago.
Intel’s return on tangible equity is definitely lower than it was 10 years ago:
Is Intel a Commodity Business?
This is how Intel describes its industry:
“As unit volumes of a product grow, production experience is accumulated and costs typically decrease, further competition develops, and prices decline.”
That sounds a lot like a commodity business.
It reminds me of something Tom Russo said to Bruce Greenwald’s value investing class:
“I think…the last person to smoke a Marlboro may have a higher brand loyalty and a higher tolerance to pay than the last person buying a Dell computer. To me that is the ultimate commodity and one that is really threatened by technology.”
The same can be said about Intel. Both Dell (DELL) and Intel have earned great returns on capital. Dell is a low margin business. Intel isn’t. But could be.
Intel’s margins depend on low costs not high prices. Margins can get as narrow as competitors are willing to make them.
Because Intel can produce more for less than its competitors, they would have to run their businesses at a loss to drive Intel’s margins to levels that would make it a mediocre business.
Intel’s fat margins are caused by competitors who can’t produce as much as cheaply as Intel - not by customers that are willing to pay up for Intel’s products.
That’s the difference between a commodity business like Dell a brand business like Altria (MO).
Intel - despite its great returns - is a commodity business.
Its extraordinary profits come from its low cost of production.
What Is Intel Worth?
Over the last 10 years Intel has generated free cash flow equal to 23.53% of tangible equity. That’s much higher than most businesses.
With AAA corporate bond yields at 5.21% investors could pay up to 4.5 times tangible book (23.53%/5.21% = 4.5) and get the same return - if Intel was sure to generate the same returns on equity it did over the last ten years.
How likely is that?
Not likely enough to justify paying $30 a share.
On the other hand Intel’s 10 year average free cash flow per share - when adjusted for the current share count - is $1.26/share. That would put the intrinsic value around $24/share ($1.26 * (1/0.0521) = $24.18).
Is Intel a Growth Stock?
No.
But it may be a cheap stock.
Intel’s past record supports an intrinsic value around $24 a share. And if Intel could earn the kind of returns on capital it did for the last 10 years the stock should be worth $30 a share.
Investors who buy Intel at $20 a share aren’t getting much of a margin of safety unless they’re sure Intel will earn better returns than it has for the last few years.
For those investors Intel is a value stock.
· Sales down 7%
· Operating Income down 6%
· Net Income up 12%
· And Earnings Per Share up 14%
Those are short term numbers. Here are Intel’s long term numbers:
Intel’s Yearly Sales Growth
1987-1994: 29.28%
1994-2001: 13.21%
2001-2008: 3.54%
I used 3 year averages to avoid measuring from the top or bottom of a business cycle. So the 1987-1994 growth rate is really the difference between Intel’s average sales for 1986, 1987, and 1988 and its average sales of 1993, 1994, and 1995.
Intel’s sales have been slowing for decades. That’s normal. The bigger a business gets the slower it grows. Few businesses will grow as fast over the next 10 years as they did over the last 10 years.
From 1999 to 2009 Intel’s sales went from $29.39 billion to $35.13 billion - growing 1.80% a year. That’s much slower than the American economy. Intel’s $29.39 billion in 1999 dollars is worth $37.77 billion in 2009 dollars - Intel had sales of just $35.13 billion.
In its best year - 2007 - Intel had sales of $38.33 billion. Even that is barely better than 1999 when adjusted for inflation.
Intel’s Investment in the Future
Part of the problem for Intel investors is the company’s heavy investments in its future. Intel is straightforward about this:
“We are committed to investing in world-class technology…Our R&D (Research and Development) activities are directed toward developing the technology innovations that we believe will deliver our next generation of products and platforms…we plan to introduce a new microarchitecture for our…processors approximately every two years and ramp the next generation of silicon process technology in the intervening year.”
That’s great news for the world. And good news for Intel’s position relative to its competitors. But it’s not necessarily good news for Intel’s shareholders.
Despite growing slower Intel has been investing more in its business.
The most important investments Intel makes are in research and capital spending. Adding these two numbers together gives us a combined “investment” number we can use to see how much Intel is spending on its progress.
Not surprisingly Intel is investing more per dollar of sales in research and capital spending than it did 10 years ago:
· From 1996-1998 Intel spent 24.19% of sales on R&D and cap-Ex combined.
· From 2006-2008 Intel spent 30.01% of sales on R&D and Cap-Ex combined.
This isn’t surprising because Intel’s sales haven’t grown much in inflation adjusted terms. It’s hard to keep costs steady even when sales aren’t growing. Most businesses’s margins and returns on capital drop when sales stand still because expenses grow even when sales don’t.
The big surprise at Intel is that combined investment in research and capital spending has grown relative to assets:
· From 1996-1998 Intel spent 19.91% of tangible assets on R&D and Cap-Ex each year.
· From 2006-2008 Intel spent 23.44% of tangible assets on R&D and Cap-Ex each year.
This suggests the competitive lifespan of Intel’s assets is shorter than it was 10 years ago. That’s not necessarily a bad thing. In fact it’s part of Intel’s strategy to force the pace of technological process.
Normally a slow-growth or no-growth business increases the competitive lifespan of its assets and decreases spending meant to maintain its competitive position - like research and capital spending.
Intel is investing more relative to assets and sales than it did 10 years ago while growing less. That suggests Intel’s return on its research and capital spending is a lot lower than it was 10 years ago.
Intel’s return on tangible equity is definitely lower than it was 10 years ago:
Is Intel a Commodity Business?
This is how Intel describes its industry:
“As unit volumes of a product grow, production experience is accumulated and costs typically decrease, further competition develops, and prices decline.”
That sounds a lot like a commodity business.
It reminds me of something Tom Russo said to Bruce Greenwald’s value investing class:
“I think…the last person to smoke a Marlboro may have a higher brand loyalty and a higher tolerance to pay than the last person buying a Dell computer. To me that is the ultimate commodity and one that is really threatened by technology.”
The same can be said about Intel. Both Dell (DELL) and Intel have earned great returns on capital. Dell is a low margin business. Intel isn’t. But could be.
Intel’s margins depend on low costs not high prices. Margins can get as narrow as competitors are willing to make them.
Because Intel can produce more for less than its competitors, they would have to run their businesses at a loss to drive Intel’s margins to levels that would make it a mediocre business.
Intel’s fat margins are caused by competitors who can’t produce as much as cheaply as Intel - not by customers that are willing to pay up for Intel’s products.
That’s the difference between a commodity business like Dell a brand business like Altria (MO).
Intel - despite its great returns - is a commodity business.
Its extraordinary profits come from its low cost of production.
What Is Intel Worth?
Over the last 10 years Intel has generated free cash flow equal to 23.53% of tangible equity. That’s much higher than most businesses.
With AAA corporate bond yields at 5.21% investors could pay up to 4.5 times tangible book (23.53%/5.21% = 4.5) and get the same return - if Intel was sure to generate the same returns on equity it did over the last ten years.
How likely is that?
Not likely enough to justify paying $30 a share.
On the other hand Intel’s 10 year average free cash flow per share - when adjusted for the current share count - is $1.26/share. That would put the intrinsic value around $24/share ($1.26 * (1/0.0521) = $24.18).
Is Intel a Growth Stock?
No.
But it may be a cheap stock.
Intel’s past record supports an intrinsic value around $24 a share. And if Intel could earn the kind of returns on capital it did for the last 10 years the stock should be worth $30 a share.
Investors who buy Intel at $20 a share aren’t getting much of a margin of safety unless they’re sure Intel will earn better returns than it has for the last few years.
For those investors Intel is a value stock.
