Like many high-tech companies, Intel has taken it on the chin this year. As of Friday, it's down about 45% for the year. But does it deserve the haircut it has received?
Overview
Intel's primary business is supplying the x86-based CPUs used in many of the computers sold on the market today. According to IDC, Intel held 64% of the desktop market and 78% of the laptop market at the beginning of the year. And in a JP Morgan research note published in June, it was noted that Intel continued to gain market share against AMD.
What's truly interesting about Intel's core business is that the shear complexity of the x86 CPUs represent a formidable barrier to entry. AMD (and to a lessor extent, VIA) are the only companies that have viable alternatives on the market; and as we'll see in a moment, AMD's fundamentals are not nearly as attractive as Intel's. VIA has only a tiny fraction of the market. Other companies such as Cyrix and Transmeta have attempted to enter the market, but have failed to be competitive. Of note is a recent $622 million investment in AMD by the Abu Dhabi government. However, this cash infusion won't put much of a dent in AMD's $5+ billion in debt.
In addition to CPUs, Intel also produces graphic chips and flash memory. Over the past year, Intel has grown its share in graphic chips to 47.3%; whereas NVIDIA has 31.4% of the market and AMD follows up with 18.1%. In the flash memory space, Intel controls about 5% of the market share, but it also only represents a minor portion of their overall business.
Investment Thesis
Over the past 5 years, both Intel and AMD have grown their revenue; but they differ dramatically when you look at earnings, cash flow and debt load. Intel has maintained a relatively consistent debt/equity ratio of about 0.05, whereas AMD's debt/equity has grown substantially over the last couple of years. In addition, Intel has delivered earnings and cash flow on a more consistent basis over time.
It's interesting to note that Intel's price/earnings averaged 21 and price/cash flow averaged about 11.5 between 2004 and 2007. However today, both ratios are down about 45%. At these levels, the market has priced in large declines in Intel's future revenue. Current analyst projections, however, suggest that next year's earnings will grow by close to 7%.
In summary, Intel's core business is difficult for competitors to crack; providing it with a strong leadership position and the ability to deliver consistent, high-quality earnings. At current prices, Intel appears to have been unfairly maligned by the market. Given the current turmoil in the market, I would wait until market momentum turns before buying Intel. However, when it rebounds (and I believe it will...) I think it's reasonable to expect that it could hit $22 to $27 per share.
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