Intel Corp. (INTC, Financial) shares are down 35% year to date, 43.50% from three years ago and 34% from five years ago. And yet, the stock is oversold for the simple reason that the markets are too zoomed in.
The legacy tech company is too often compared with Nvidia Corp. (NVDA, Financial) and Advanced Micro Devices Inc. (AMD, Financial). The comparison is fair as they have practically the same business models and Intel is currently suffering from a long period of underinvestments - although it did manage to pull off 9% year-over-year revenue growth. The reason the shares declined sharply at the start of the year was due to the weak second-quarter guidance. The company expects earnings per share of 10 cents and revenue of $13 billion, while analysts expected much better earnings of 25 cents and $13.60 billion in revenue.
But when you take a step back and focus on the business orientation, you notice Intel is headed in a completely different and new direction that actually makes the stock attractive again. And this causes the company to, temporarily, sacrifice some of its earnings. Management, which has been led by CEO Pat Gelsinger since 2021, understood that it would be difficult to catch up to competitors without establishing its own moat.
Its business orientation makes it an interesting long-term bet as the company positions itself to become one player within a global duopoly shared with Taiwan Semiconductor Manufacturing Co. Ltd. (TSM, Financial). Taiwan Semiconductor is the world's largest foundry with approximately 60% market share and is located in Taiwan, where geopolitical tensions are high between China, the U.S. and Taiwan. These tensions forced the U.S. Congress (where the Senate was majoritarily Republican) to adopt the CHIPS and Science Act proposed by the Democratic Biden administration. The act aims to ensure the long-term supply of critical semiconductor chips that are found in all electronic devices such as computers, cars, military engines, etc. by creating chips manufacturing facilities on U.S. soil. Intel will be the main benefactor of the CHIPS Act with up to $8.5 billion in grants and $11 billion in loans from the U.S. government. This is a much welcome boost that could allow the company to regain its edge against the competition.
Business overview
Intel's global business is divided into a few separate segments.
Source: Intel first-quarter 2024 report
The fastest growing and by far the largest business segment is Client Computing Group, which represents 59% of the company's revenue and most of its growth rate. This segment is the one Intel is famous for: it sells PCs and laptops to customers around the world. It is also, for now, the main source of growth.
There are a few other business segments that are struggling with no or low growth, such as Data Center and AI (the real disappointment in relation to Nvidia and AMD's artificial intelliegence progress), Network and Edge (network edge infrastructure), Mobileye and Altera (smaller businesses acquired by Intel) and Foundry, its second-largest business segment by revenue.
Foundry is the business segment with the biggest potential and has turned into the priority of Gelsinger and his team since his arrival. The business will essentially rival chip manufacturer Taiwan Semiconductor. However, it is also by far the most capital-intensive business segment, causing Intel to lose $7 billion in 2023. Experts expect the business to break even in 2027, at which point profitability will grow from there. Therefore, any long position initiated should be held at least until 2027; the stock is potentially an attractive investment given the promising prospects in the foundry business, even supported by the U.S. government, but only for investors with a sufficiently long investment horizon.
We will now look whether initiating a long position now is wise or if it is advisable to wait for better numbers.
Financials and valuation
Revenue and net income peaked in 2021 and have been declining ever since.
2021 revenue of $79 billion and net income of $20 billion turned into disappointing $54 billion and $1.7 billion by the end of 2023. Due to a severe lack of investment in the years prior, Intel started falling behind its main competitors with stark declines over 24 months. In the same period, return on equity fell from 22.50% to 1.60%. The Ebitda margin followed a similar trajectory with a decrease from 42.90% to 17.80%. The current ratio (i.e., its ability to meet short-term obligations) is still comfortably above 1 (below 1 means the company cannot meet its short-term obligations with its current assets) and, therefore, a potential bankruptcy scenario remains out of the picture. However, the rapidly declining revenue, net income, ROE and margins justify the sell-off in recent years.
From a valuation perspective, the stock does not look attractive. The total enterprise value currently trades close to 16 times Ebitda, much higher than the average of 6.50 in the five years prior. The stark valuation is for a more artificial reason than any market optimism for the stock. Ebitda declined sharply, causing the valuation to appear more expensive. A catch-up of the earnings after the Foundry bet turns successful would recorrect the valuation without requiring additional stock sell-offs.
The negative evolution of the financials and valuation metrics scared off many investors. Therefore, investing in the company's stock today is rather a turnaround (or even a speculative) play within a diversified portfolio for investors that believe in the rebirth of the business model supported and subsidised by the U.S. government, rather than a decision based on the recent hard figures. The stock remains an attractive investment given the renewed business model. Investing is the art of catching falling knives, and Intel could well be one of those turnaround success stories.
Risk factors to my case
Intel's growth is strongly dependent on CCG's resilience and, therefore, dependent on consumer electronics demand to continue financing its Foundry business and turnaround. Foundries are capital intensive and Intel will burn enormous amounts of cash for a couple of years. Therefore, the main risk is if the CEO's renewed business plan does not go as expected and delays occur. Then the company could end up in trouble with regards to maturing obligations. Financing and refinancing capital-intensive business activities could prove costly (literally and figuratively) in a high interest rate environment like today's. The most patient investors might, in turn, become impatient due to the probable absence of share buybacks in the next few years and could cause an accentuated sell-off.
Bottom line
Although Intel's stock has been under pressure and might remain that way given its struggling segments and the new capital-intensive foundry business, the company may be at its turning point. The fact it does not try to directly challenge Nvidia, AMD or Qualcomm (QCOM, Financial), and instead walks away to create its own edge (a U.S.-based semiconductor foundry) makes the stock highly interesting for a long-term investment within a diversified portfolio. Its financials and valuation reflect past business performance; however, in the case of Intel, it is worth paying attention to the business strategy remodelling and consider holding the shares for a period of at least three to five additional years.
