Ignore earnings -- own Intel for the long haul
Dismal conditions in the PC market are hobbling the world's largest semiconductor maker. But Intel is making the investments it needs to excel in other markets.
By Joseph Hogue
Companies must spend money to make money -- at least, that's what many investors believe.
The market has long followed research and development (R&D) and capital expenditures (or capex, for short) with the idea that companies making investments in these areas will see huge payoffs in revenue somewhere down the line.
When the increase in capex works out, investors are rewarded. The issue is that the market has a problem with timing the jump in future revenue. When the stock price bounces too early and the revenue is not there to support it, then shares retreat downward.
One major tech company is waiting for its recent R&D investments to pay off. I'm talking about Intel (INTC), the world's largest maker of computer chips.
The Santa Clara, Calif, company today reiterated its sales and margin forecasts for this year, even as first-quarter PC sales slipped nearly 14% from a year ago. Intel also met analyst estimates for its most-recent quarter, though the forecasts had been dimmed by ongoing weakness in PC sales.
Short-term pain, long-term gain
Back in September, I argued that a 4.2% dividend yield and the cheapest valuation in a decade made Intel a huge "buy." Although the company has continued to encounter short-term weakness, the potential I've outlined still applies.
Intel said it would have $13 billion in capex this year, an 18% increase over 2012 and well above the Street's estimates of $8 billion. Capital expenditures are taken off of income in the quarter they occur instead of being held on the balance sheet as an asset, meaning that the increase in Intel's capex will probably lead to lower 2013 earnings than originally expected.
Shares have been volatile through April, when the R&D myth started to take hold and the stock popped upward 6% on positive expectations for the first-quarter report.
The problem is that higher revenues will probably lag behind investor expectations considerably, and the shares could suffer in the interim. The mix of spending for this year is shifting to equipment, which has a longer development cycle and probably won't see a payoff until 2014 or 2015.
In February, Intel said it would begin production of configurable chips for Altera (ALTR). The project marks a significant departure from Intel's business model as a designer of proprietary chips to a high-end chip foundry for customers. The project carries significant scale in production, something Intel is capable of doing, but lower margins on pricing.
Investors have been positive on the deal, not because it will add much near-term income, but because it could lead to a foundry deal with Apple (AAPL). The foundry deal with Altera has a fairly long development cycle, so a payoff in the form of an agreement with Apple could be more than a year away.
So what does it mean for investors?
The short-term question really is: Have the increase in expenses and lower margins been built into Intel's stock price?
Investors see the Altera project as an opportunity for a deal with Apple, but they may not realize the implications of the current quarter's higher capex or the time it may take Intel to prove its foundry business. While the new line may eventually lead to a relationship with larger buyers like Apple, it is likely to be a money pit in the short term.
Long-term investors can feel comfortable with the 4.2% yield as they wait for a turnaround. Short-term investors may want to wait a few months. Intel has historically held about one year's worth of capital expenditures in cash on its balance sheet. It had $8.5 billion in cash at the end of the fourth quarter, so it will probably be adding to cash in this quarter. This means that while the dividend is almost certainly safe, Intel might not buy back as many shares as usual.
Intel is expected to post a 23% decline in earnings per share compared with the first quarter of 2012. Based on its history, Intel should have no problem beating the EPS estimate, but investors could still be disappointed if there is no guidance on the mobile or tablet businesses or a lack of progress in the search for a new CEO to replace departing chief executive Paul Otellini.
Risks to consider: Intel is considerably underpriced and underappreciated relative to its lead in chips and future cash flow projections. Waiting to buy because of near-term weakness risks missing out on a big move to the upside on a positive headline, but long-term profits should still be available without the risk of a near-term drop.
Action to take: While I still like Intel's prospects in the long run, investors may be in for a rude awakening when Intel reports first- and second-quarter earnings that show significantly higher expenses and lower margins without any guidance on higher incremental revenues.
Joseph Hogue owns shares of Intel.
More from StreetAuthority
No discussion of Intel's past flubs in new ventures?
No discussion of the fact that processors prices have been dropping throughout the 2000's?
No discussion of competition from AMD in processors?
No discussion of competition from other manufacturers in other types of chips?
You're not only asking us to ignore earnings, you're asking us to ignore everything!
" probably won't see a payoff until 2014 or 2015."
2012 eps and consensus analyst earnings/share projections:
2014 appears out.
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