Intel: An Undervalued Stock Offering Potential Double-Digit Returns

The current bull market has lasted more than a decade, making it one of the longest bull markets on record. The S&P 500 just finished its best year since 2013, posting a total return of more than 30% for the year. The average price-earnings ratio of the S&P 500 is 24.4.

Knowing this information, investors looking for value might feel as if the market has gotten away from them. However, there are some stocks of companies performing very well that trade with a relatively low valuation compared to the rest of the market.

Despite a 35% increase in share price over the last year, I feel that Intel Corporation (NASDAQ:INTC) is an example of an undervalued stock investors might consider buying.

Recent earnings results

Intel, which has a market capitalization of more than $285 billon, recently reported earnings results on Jan. 23. Intel’s adjusted eanings per share for the fourth quarter came in at $1.52, which was $0.27 above estimates and shows a 19% improvement from the previous year. Revenue grew more than 8% to a quarterly record of $20.2 billion, smashing estimates by $980 million.

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Results for the full year didn’t disappoint either. Adjusted earnings improved 6% to $4.87 per share while revenue increased 2% to $72 billion.

Nearly every business within Intel grew for both the quarter and full year. The company’s data-centric businesses produced a fourth quarter record revenue of $10.1 billion. This segment was led by the Data Center Group, which saw sales grow by 19% to $7.2 billion. This segment saw an acceleration in sales as results were higher by just 2% for the entire year. Increased demand from cloud service customers was a major contributor to growth in the quarter. Also aiding results was product mix of high-performance processors.

The Internet of Things Group improved by double-digits for both the quarter and year. Demand from retail and transportation customers were primarily responsible for growth. Higher product adoption rates helped Mobileye grow 31% and 26%, respectively, for the quarter and year. Product growth caused sales to be higher by 10% in the fourth quarter for Intel’s memory business. The only data-centric segment to show declines in either the quarter or year was the Programable Solutions Group, which was down 17% in the fourth quarter and 6% for 2019.

The PC-centric business, which contributed slightly more than half of annual sales, saw a 2% improvement in the quarter, though results were flat for the year. Higher modem sales and increased volumes of desktop platforms helped to lead this business to growth.

Intel’s gross margin for the quarter was 60.1%, which was 1.6% lower than the previous year but topped estimates by 1.7%. The company had a record $33.1 billion of cash from operations and generated $16.9 billion of free cash flow. Intel used this capital to distribute $5.6 billion in dividends during 2019. The company also spent $13.6 billion to repurchase 272 million shares at an average price of $50. Considering shares trade above $65 today, this appears to be a good use of cash. Intel ended the year with more than $13 billion in cash and equivalents on its balance sheet.

Intel expects adjusted earnings per share to improve 2.7% to $5.00 for 2020 and revenue to grow 2% as strength in data-centric businesses will be partially offset by the PC-centric business.

Intel saw strong growth on both its top and bottom lines in the quarter. Revenue and earnings per share growth accelerated through the fourth quarter compared to the rest of the year. Every segment except for one saw growth for the quarter and year. The company also returned more than 100% of free cash flow to shareholders and still has a sizeable cash balance.

Dividend and valuation analysis

Intel recently raised its dividend by 4.8% for the dividend payment scheduled for March 1, 2020. This marks the sixth consecutive year that the company has increased its dividend. Prior to pausing its dividend growth in 2014, Intel had managed a decade of dividend growth.

The company has compounded its dividend by:

• 5.2% per year over the last three years.
• 5.6% per year over the past five years.
• 7.2% per year over the past 10 years.

Dividend growth has remained relatively stable over the past five years, and growth is likely sustainable going forward due to the low payout ratios. Shares yield 1.8%, which is well below the 10-year average yield of 3%.

Using the new dividend of $1.32 and expected adjusted earnings of $5 per share for 2020, the forward payout ratio is 26%, which is below the 10-year average payout ratio of 36%.

Intel paid out $5.6 billion in dividends in 2019 while generating $16.9 billion of free cash flow for a payout ratio of 33%.

Both the earnings per share and free cash flow payout ratios are extremely low, giving the company plenty of cushion to continue growing its dividend.

Intel’s stock closed the most recent trading session at a price of $65.69. Using expected adjusted earnings of $5 per share, shares have a forward price-earnings ratio of 13.1. If the stock were to average this valuation for all of 2020 then this would be Intel’s second highest price-earnings ratio in more than a decade.

But Intel is a different company than it was just a few years ago. The data-centric business, especially the Data Center Group, should continue to see robust growth. The public cloud market could almost double results from 2018 by 2022. This gives companies like Intel, which have a leadership position in the cloud service business, a long runway for growth. Due to this business, Intel has guided towards $6.00 of eanings per share by 2023.

Thus, I feel that a price-earnings ratio in the range of 15 to 16 seems appropriate given Intel’s current business performance and opportunities for future growth. Using earnings per share estimates of $5.00 for the current year, shares at my valuation target would fall in a range of $75 to $80. This would result in a 14.2% to 21.8% gain from the current share price.

Final thoughts

Finding shares of companies that are performing well and trading at a low valuation is difficult in the current market, but Intel appears to be one such company. Intel had a strong end to 2019, with sales records in several businesses. While the current yield is on the low side, the company’s earnings per share and free cash flow payout ratios are very healthy. In addition, Intel’s shares trade with a price-earnings ratio that I feel undervalues the company’s strength in cloud services. Give these factors, investors buying Intel today could see at least mid-double-digit returns.

Disclosure: I am not long Intel.

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