Quite simply, investors are worried that the growth story has come to an end. Intel is the dominant company in PC and laptop processors… But, right now, they’re just another player in the very competitive market for mobile phone and tablet processors. And if mobile phones and tablets continue to replace PCs and laptops, Intel will see its moat (and earnings power) evaporate.
Returns on Capital
Let’s start by looking at just how good Intel’s returns on capital are.
Over the past 12 months, Intel has earned almost $16.9 billion in operating income. They’ve done that with just $55 billion in tangible assets, and included in the asset total is a significant net cash and non-operating investments.
That’s almost a 31% return on capital without making any adjustments for their excess cash balances or any non-cash, non-economic expenses. Normally, we’d make those adjustments and see just how strong Intel’s true earnings power is.
But in this case, we really don’t need to make any adjustments to see that Intel is generating outstanding returns on capital consistent with a business with significant competitive advantages.
So how cheap is Intel trading for? With operating income coming in at $16.9 billiob and an EV value of $115.3B, Intel is trading for just over 9x EV / EBIT. If we back out non-cash charges, Intel trades for a bit over 5x EV / EBITDA.
Obviously, that’s cheap. At this level of valuation, the market is pricing in a very, very rapid decline of Intel’s moat over the next two to three years.
There are likely three scenarios for Intel. In the first scenario, what the market is pricing in comes to pass. Mobile and tablets rapidly replace PCs and laptops, Intel’s moat rapidly declines and their earnings power is shot. Note that while Intel’s stock likely will perform poorly in this scenario, it doesn’t mean it will be a complete loss; for example, AMD has operated at a significant disagvantage to Intel over the past 15 years but still has managed to stay alive.
In the second scenario, Intel makes some in roads into the mobile market and their PC and laptop moat slowly, but never completely, erodes. In that scenario, Intel’s stock is likely modestly undervalued, and investors will do pretty well over the next two-three years.
In the last scenario, Intel figures out mobile and tablets and comes to dominate it like they currently dominate laptops. In that scenario, Intel’s stock is massively, massively undervalued and investors would hit a homerun at today’s prices.
Which scenario is most likely???? It’s almost impossible to tell, but given Intel’s history of successful innovation, it seems pretty risky to bet on the first case. This isn’t quite “heads I win, tails I break even.” It’s more heads I lose a bit, tails I hit an absolute home run. This is the type of scenario that we really like to look for in GuruFocus’ own Micro-Cap Magic Formula newsletter. We’ve accumulated a pretty interesting portfolio of companies with these characteristics — if you’re interested in more situations like this, you should check it out.