During an investor meeting at the end of 2014, microchip giant Intel Corporation (INTC) emphasized ambitions to use its strengths to “move into profitable, complementary markets.”
That statement might scare off some investors, including someone like Warren Buffett, who prefers that a company consistently make money in the same business for decades at a time.
But for Intel, it has been on a multi-year strategy to diversify out of selling chips that power computers, which, as most people know, grew gangbusters for years, but is no longer a growth industry.
Intel’s dominance in computers is still important, but the firm has increasingly sought to sell servers and computing power to support the growth of the internet. These new businesses are intensely competitive, but also very profitable and growing rapidly (fitting Intel’s goal of profitable, complementary markets).
Intel’s diversification efforts appear to be paying off and the timing could be ripe for the stock to finally take off again. Even if it doesn’t, the valuation is extremely reasonable, and investors are getting paid to wait for a more potentially lucrative payday, or namely a run in the share price.
Intel Is Dominant
Intel specializes in and dominates the market for microprocessors, more simply known as computer chips. It essentially revolutionized the industry for computing power and has had a profound effect on the influence of technology on boosting productivity in the global economy. There is certainly an argument to be made that transistor chips are the most important invention in the last century, and Intel has been at the forefront of the microchip’s importance in society.
Moore’s Law, which roughly states that the number of components on a chip should double every year, has basically held since Gordon Moore first proclaimed it in 1965.
Moore eventually worked for Intel and helped the company created a culture and businesses that have kept Moore’s Law alive and well. Management attributes its adherence to Moore’s Law to manufacturing volume (which lets costs per chip decline while supporting scale), a brand that resonates with consumers, and research and development. All have combined for an enduring competitive advantage.
Intel, along with Microsoft Corporation (MSFT) who it counts as a rival but has also had a symbiotic relationship with (think the dominant Wintel franchise in personal computers that dominated in the 1990s), is one of the most successful tech companies of all time. Apple Inc. (AAPL) deserves mention as another tech giant, but sports a lower dividend yield than Intel, and I am more concerned about future sales of the iPhone than I am Intel’s microchips.
Despite its recent growth struggles, Intel is still the largest semiconductor firm on the planet, with chips in 80% of PCs sold worldwide. It will continue to be dominant, and its computer divisions are the cash cows for it to expand into faster growing markets.
The Strategy Shift
Intel’s multi-year strategy to reduce its reliance on personal computers continues to bear fruit. In many respects, the firm has had no choice but to regroup from the steadily decreased consumer reliance on desktop and laptop computers. Individuals now get just as much utility from accessing email and apps from their smartphones, and tablets to a lesser extent.
Intel’s Client Computing Group, which emphasizes notebook and desktop computers, accounted for two-thirds of sales a couple of years ago, but is now right around 58%. The big shift has been to the Data Center Group that has grown to 30% of the top line, up significantly from 23% in 2013. This unit focuses on providing the chips and computing power for data center platforms that International Business Machines Corp. (IBM) championed originally back in the 1980s.
Ironically, the Internet of Things has brought servers back to the forefront of computing, and Intel is frantically shifting its resources to this business. It supplies microprocessors and related components, operating systems and software. It sells to enterprise customers, cloud computing providers and communication capabilities to tech and telecom firms. Its IoT division only currently represents 4% of sales, but has big potential. Big Tech rival Cisco Systems, Inc. (CSCO) also competes in the IoT space, but sells lower margin hardware to telecom firms.
Intel Is Insanely Profitable
Last year, Intel reported $55.4 billion in sales and $11.6 billion in free cash flow. That absolute level of profitability is astounding, as is the profit margin of 21%, meaning 21 cents of every dollar in revenue falls straight to the bottom line.
This level of profitability benefits shareholders in important ways. It leaves billions for annual share buybacks and allows the company to easily support a generous dividend yield of nearly 3.5%.
Most importantly, Intel’s prodigious cash generation also leaves ample dry powder to pursue acquisitions and continue to build out its server, cloud and IoT capabilities. Its acquisition of archrival Altera, completed just recently at the end of its fiscal 2015, adds important programmable chip technology in the data center and IoT businesses. It has plenty of resources to make future bolt-on acquisitions.
Still a Show-Me Stock
Combined, Intel’s non-computing businesses have grown to 40% of sales and 65% of its operating profitability. Management is quick to point out that consumers need a network for their smart devices to get to the cloud and utilize social media, as well as work, applications.
Intel is not fully transitioned from computers, but appears to be over the hump. The computer business should still stay viable for many years because businesses will likely always rely on them to run their operations.
Earnings expectations have ticked up over the past month. Analysts project earnings per share of $2.41. At the current share price around $30, the price-earnings ratio of 12.4 is quite reasonable, and should drop a point to 11.5 based on 2017 projections.
Throw in a current dividend yield of 3.5% and there are certainly worse places to invest your money. Intel isn’t growing as fast as during its heyday in the Wintel years, but offers respectable growth (and income) at an earnings multiple well below the market average of close to 24.
As of this writing, Ryan Fuhrmann did not hold a position in any of the aforementioned securities.
