(NASDAQ : INTC)
Stock Report | Student Managed Fund
February 9, 2004
Chris Bodnar MBA Candidate May 2004
BUSINESS SUMMARY: Intel Corp is one of the world's largest semiconductor chip makers, supplying the computing and communications industries. Products supplied to these industries by Intel include microprocessors, chipsets, network processor chips, embedded control chips, and flash memory used in cellular handsets and handheld computing devices. Board level products include Ethernet network interface cards and complete PC motherboards for OEMs. End markets for Intel products include Personal Computers (PCs), servers, and networking and communications equipment.
Symbol: INTC Market: NASDAQ NM Employees: 86,100 OS Shares: 6,532 mil. Mkt Cap: $199.7 bil. Date: Price: Div. Yield: 52 Wk-H: 52 Wk-L: % of High: % of Low:
2200 Mission College Blvd. Santa Clara, CA 95052-8119 www.intc.com
2/9/04 $30.57 .52% $34.60 $14.50 98.6% 204.5%
PE (TTM): Fwd PE (5y): PEG: (5y) (3y) Sharpe ratio: Treynor Ndx:
35.93 x 24.2 x 1.6 2.04 6.64% .096 .027
GICS SECTOR: Information Technology SUBINDUSTRY: Semiconductors
Peer Subset: Adv. Micro Devices Altera Corp. Fairchild Semi. Infineon Technologies Integrated Device Tech. LSI Logic STMicroelectronics Xilinx, Inc. AMD ALTR FCS IFX IDTI LSI STM XLNX
STANDARD & POOR’S 2/7/04 Date Buy S&P Opinion 5 Stars 4+ Outlook $32.40 Fair Value 209 Invest.Quot. $45/sh 12 Mo. Target A Earn./Div. Rank Buy S&P Adj. Consensus 47 No. of Analysts Rptng
1 to 5 1- to 5+ 0 to 250 D to A+
Value Line Date 1/16/04 3 Timeliness 3 Safety 3 Technical A++ Fin. Strength Ind. Ranking 10 of 98 $60/sh Target High $40/sh Target Low
BODNAR RECOMM.: BUY
Disc.Earnings: Disc. FCF: DCF 1yr. Fwd.:
Value $32.19 36.94 42.30
Upside to Target 5.0% 20.8% 38.4%
Intel (‘Intel’, ‘INTC’, or ‘the Company’) is the world’s largest semiconductor chip maker. It is well known for its dominant market share in microprocessors for personal computers, estimated at approximately 80%. Although the PC processor is a commodity, INTC has expanded its product lines to serve the networking and communications markets. The company’s stated mission is to be the preeminent building block supplier to the worldwide Internet economy, indicating that its ambitions extend well beyond just PCs. The Company’s main operating groups are: Intel Architecture Business (more than 83% of total sales in 2002), Intel Communications (8%), and Wireless Communications and Computing (8%). Intel Architecture Group (IAG) The Intel Architecture Business Group works on microprocessor and chipset products for the desktop and mobile computing platforms, as well as high-performance microprocessors for servers and workstation markets. Intel introduced the first microprocessor in 1971, and has been the technology leader ever since. Wireless Communications and Computing Group (WCCG) The INTC WCCG makes a variety of wireless-related chips for handheld devices, mobile phones, and wireless computing. The products include:
Application Processors Baseband Chipsets Flash memory
Process the data functions on calendar and email programs for wireless handheld devices and cellular phones Enable voice communication A type of memory used for code storage in such devices and retains data when a device's power is turned off.
While IAG continues to dominate Intel's revenue, WCCG is likely to grow at a faster rate over the long term. Additionally, IAG and WCCG will be driven by end-user products outside the traditional PC and handset market, including products like the XBOX, Digital Video Recorders, Home Gateways, PDAs, and mini-servers to store digital content & distribute it around the house.
Internet Communications Group (ICG) The ICG makes chips used in a variety of communications systems including Internet infrastructure, corporate networks, access devices and local area networks and home networks to name a few. INTC produces both hardware and software for voice and data networks. The products span copper and optical networks and include end products such as:
Network communications hubs Routers Switches
Cellular phone base stations Factory floor automation instruments Laser printers
The chip industry has historically been subject to intense boom and bust cycles, but in the 19752000 period, annual sales growth averaged 16.1% according to Semiconductor Industry Association data. As the industry matures, this cyclical trend is likely to continue, but the longterm growth rate for the industry as a whole is also likely to come down. During 2003, the Philadelphia Semiconductor Index (^SOXX) outperformed the broader market year (see below). Because the index is market-capitalization-price weighted, its return is greatly dependent on the performance of Intel – aka. the world’s largest chip company. If the economy continues to grow at its current pace, the semiconductor industry follow suit. Additionally, increasing obsolescence of tech equipment bought in 1999 for Y2K compliance could bolster the performance of this sector
semiconductor companies ranked by semiconductor revenues is
shown in Table 1. The list also reveals the industry’s international scope. Japan The United States and each contribute three
companies to the top 10; Europe has two; and South Korea has one. INTC is almost three times larger than the No. 2 company, Samsung Electronics Co. Ltd. In fact, Intel’s sales in 2002 were higher than combined sales for Samsung plus the next two largest chipmakers, Texas Instruments Inc. and STMicroelectronics NV. Philadelphia Semiconductor Index (^SOXX) The SOXX was created in December 1993 and is market cap price weighted index composed of 18 US semiconductor companies primarily involved in the design, distribution, manufacture, and
sale of semiconductors. The following is a list of the names of the companies currently included in the SOXX:
Altera Corp Applied Material ADV Micro Device Broadcom Corp INTEL Corp. KLA Tencor Linear Technology Corp. LSI Logic Corp. Motorola Inc. Micro Technologies Maxim Integrated Products National Semiconductor Novellus Systems Inc. STMicroelectronics NV Teradyne Inc. Taiwan Semiconductor Texas Instruments Xilinx Inc.
The following chart shows Intel’s 5-year cumulative weekly returns plotted against the SOXX and the S&P 500 Indicies:
The results of this time series plot can be summarized as follows: Cumulative Return (%)
17.38 43.51 - 9.50
INTC SOXX SPX
PV of $10K invested on November 30, 1998
$11,738 14,351 9,050
Revenue (Millions of $s)
$29,389 $26,273 $26,539 $26,764
Revenue (Millions of $s)
1.8 1.8 INTC’s Y/Y trend in revenue is shown above. The Company’s top line has won it the spot of the 1.6 1.2 0.8 0.4 1.6 1.2 0.8 0.4 1.4 1.4 largest market share out of all semiconductor manufacturers in the world. It had captured 1.57 1.57
1.1 1 $28.6B through 1.1 TTM ending September 30, 2003. The industry average for INTC’s peer the 1 0.6 group was only $695M for the same period. The 2001 drop-off in revenue is attributable to the 0.6 0.47 0.47 0.2 contraction that occurred in the U.S. economy as a result of the burst of the technology bubble. 0.2 0.19 0.19 1998 1999 2000 The Company1999 on target to grow its Y/Y revenues by 10% at FYE 2003. is 1998 2000 2001 2002 0 0 2001 2002 0.91 0.91
1.8 1.6 1.4 1.2 1.57
0.8 0.7 0.6 0.69
1 0.8 0.6 0.4 0.2 0 1998 0.91
0.5 0.4 0.3 0.2 0.1 0 0.05
1.8 The Semiconductor industry has experienced 1.8 contractions beginning in FY 2000 – INTC 1.6 1.2 0.8 0.4
included. This period mirrored the broader U.S. economic downturn. There are two notable 1.4 1.4
1.1 1.1 observations: INTC’s earnings bounced beginning in FY 2001 and the Company has produced 1 1 0.91 positive 0.91 (Q1 2003 EPS was 0.47 EPS unchanged) for seven consecutive quarters. 0.47 Company The 0.6 0.6 0.8 0.4 1.2
continues to garner the largest share of earnings of the semiconductor market. 0.2 0.2 0.19
0.19 0 1998 1999 2000 2001 2002 0 1998 1999 2000 2001 2002
35.0% 30.0% 31.2% 24.9%
Net Profit Margin
25.0% 20.0% 15.0% 23.1%
Net Profit Margin
10.0% 5.0% 0.0% -5.0% -10.0% -15.0% -20.0%
10.0% Philadelphia Semiconductor Index 5.0% 4.9% 0.0% 1998 1999 2000 2001 2002
1.8 INTC’s net profit margin tracks to its earnings. 1.8 1.6 1.2 1.57 1.6 1.2 0.8 0.4 0.19 1998 1999 2000 2001 2002 0.2 0
This is indicative of the scalability and
1.57 1.4 leveragability of Company’s operations to meet demand and contain costs during times of plenty 1.4
0.91 solid net profit margins in contrast to the industry’s losses. 0.6 0.6 0.47 0.4 0.2 0
1.1 and1contractions. Once again, INTC demonstrated dominance1.1 over its peer group by producing 1
$0.10 DPS Yield $0.08 $0.07 $0.06 $0.04 0.645% 2002
INTC began paying dividends in 1993. Over the last ten years, it has grown its dividend at a 25% CAGR. This compares to an 8% CAGR in EPS over the same period. Its annual dividend in 2003 is expected to match the 2002 payout level. The annual yield remains low because INTC’s stock value is relatively high, trading at PE multiples of
1.8 approximately 30x on average 30x over the long run. Intel is only one of a 1.6 1.57 $0.08
handful of semiconductor companies in the 1.2
industry to pay a dividend. According to Value 0.8 0.91 Line, dividends are expected 0.47 grow at to 0.4
0.19 approximately 11%-12% over the next five 0 0.2 0.6
D P Y S L
$0.01 0.239% TTM 0.097% Peers TTM
Capital Structure & Leverage
0.40 0.35 0.30 0.25 0.3770
INTC’s balance sheet is strong.
Company is extremely deleveraged in its capital structure relative to the industry average.
0.0300 0.0294 0.0189 0.0293 0.0262 0.0236
0.20 0.15 0.10 0.05 0.00 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 TTM Peers TTM
This contributes to its overall
financial strength and lower financial risk inherent in the business. Value Line gave
INTC its highest rating of A++ for financial
strength. The small amount of debt that Intel carries is not a burden on earnings either as its TIE ratio is 108x that of the industry average for the
Interest Coverage Ratio
120 102.8 100 80 60 40 20 (20) TTM
TTM period. The Company’s interest coverage ratio used to be much larger than it currently is weighed down in recent years by the pattern in revenues. The amount of debt the Company carries in its capital structure has remained fairly constant over the last decade.
(5.5) Peers TTM
term and fixed assets have remained fairly constant over the last decade. Once again, this 0.15
0.10 demonstrates how the economic downturn that weighed 0.0300 0.0294 the tech sector beginning in heavily on 0.0189 0.0293 0.0262 0.0236 0.05
FY 2000 affected INTC’s ability to generate 0.00 substantial revenue from its foundries.
Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 TTM Peers TTM
30.0 25.0 20.2 20.4 16.6 7 2.9 21.7 24 19.3 16.7 22
20.0 15.0 10.0 5.0 0.0
0.25 Intel’s management efficiency can be best shown through an analysis of ROA (see below). Long 0.20
Stock Valuation & Modeling
The following analysis and assumptions made for the same were based on information extracted from the Value Line Investment Survey for Intel.
Required return The required rate of return on an investment in INTC can be approximated by using the Company’s cost of equity calculated by the CAPM K e R f ( Rm R f ) Rf Rm 3.5% 7.5% 1.35 Therefore, by applying the CAPM, the required rate of return on INTC is: K e 3.5 1.35 (7.5 3.5) 8.9%
Growth By multiplying INTC’s ROE by its the retention rate (b), we are able to estimating the company’s growth rate. A growth rate of 15.96% is assumed. ROE DPO b (1-DPO)
g ROE b
5yr 17.4% 10.6 89.4
10yr 23.7% 6.9 93.6
Gordon Constant Dividend Growth Model Since Ke < g, this model can not be used. A multi period dividend discount model is more appropriate for INTC.
Multi Period Discount Model based on Dividends: Assumptions: Years Supernormal Growth: @ growth rate g1: Required Return (Disc.Rate): Normal growth beg. in year 6 (g2): Disc.Rate during normal growth: 5 15.96% 8.9% 5.0% 8.9% INTC’s T0 dividend is $.10 per share. 1. Compound dividends in yr.1-5 at the growth rate and discount each back to the present. 2. Compound yr. 5 dividend by the normal growth rate and discount it back one period at D6 Ke-g to find the Ke gn price of the stock in year 5. 3. Discount the price back to the present.
This method yields an intrinsic INTC value of $4.12
Multi Period Discount Model based on Earnings: The intrinsic value based on dividends does not properly value the stock. Since Intel’s average plowback ratio is over 90%, discounted earnings would be a better proxy for the value of the firm. Employing the same methodology as the multi period discount model (above) substituting earnings for dividends yields: Intrinsic INTC Value of $32.19
Value Implied by PE Ratio: 5yr INTC Average PE: T1 Earnings (2004) Since 40.5x $1.00/share
P Price then PE EPS Price 40.5 $1.00 E
INTC Value of $40.50
Intel Corporation (INTC:NASDQ) Market Quote (12/11/03): Multi-Pd. Discounted Earnings: Implied PE Ratio:
Value $30.91 32.19 40.50
Intel’s valuation based on the PE method is approx. 25% higher than the implied value in the PE Ratio. This is primarily the result of the exorbitant growth rate(s) baked into PE ratios dating back to 1999; a time in hindsight when the market was considered to be severely overvalued. Additionally, Value Line's one-year EPS growth estimate is slightly higher than the one assumed to discount earnings.
PE Model: The PE Model would not be used in this analysis because the required rate of return (Ke of 8.9%) is less than the stock's expected growth rate of 15.96%. This produces a negative number in the denominator of the equation: P0
E1 ( DPR ) kg
ValuePro.net Model: The Valuepro.net model is a proprietary software package that makes certain assumptions about the company to project future free cash flow and a terminal value and discounts them at the firm’s WACC. Some of the assumptions Valuepro.net used to arrive at its price are as follows: Period Growth Rate WACC 5 yrs 15.96% 8.88% 1
The WACC closely resembles the calculated required rate of return on Intel (Ke= 8.90%). This is positive given the fact that Intel has very little debt in its capital structure and the cost of debt would have only a marginal effect on the overall cost of capital.
INTC Value of $13.23
The current market price of the stock is approximately $30 per share. Since Intel is a growth stock in a technology sector, the street is valuing the future earnings potential of the company. As such, the multi stage earnings growth model that values the Company at approximately $32 per share gives substance to a BUY recommendation on Intel at its current level.
Other analysts providing coverage: ANALYST CSFB Banc of America Argus Standard & Poors
RECOMMENDS 12 MO. PRICE TARGET
Buy Buy Buy Buy
34.50 32.00 38.00 45.00
NON-SYSTEMATIC The following are major risks that INTC faces as a company:
Manufacturing Risk. Intel owns and operates manufacturing facilities around the world, which create large fixed costs. These facilities are a competitive advantage during boom cycles and weigh significantly on operating leverage during recoveries. They represent a drain on earnings and cash flow in downturns. In addition, the escalating costs and revenue requirements for building an advanced semiconductor fabrication facility are becoming prohibitive for most semiconductor companies. Roughly 70% of INTC’s manufacturing occurs in its U.S. facilities, while the remaining 30% of its manufacturing takes place at its facilities in Israel and Ireland.
Technology Risk. INTC is at risk of introducing a step-function technology into the marketplace. This could render many or all of Intel's technologies obsolete. Key Talent Risk. The Company’s business model is built upon continuous innovation. A loss of key employees could hurt INTC’s long-term prospects.
Product Risk. INTC has focused its products on several high-volume end-markets (e.g., PCs and wireless handsets). While the end markets have proven to be successful growth markets over the last decade, there is always the risk of a lack of growth due to competing applications or other product fads.
Customer Risk. The Company derives the majority of its revenue from the large PC OEMs such as Dell, Hewlett Packard, and IBM etc. Material problems for those companies could result in material risk to INTC’s revenue and/or profitability as well.
Warranties. INTC often sells its products with warranties against defects that could have a material impact on Intel's earnings. Given the increasing complexity and volume of the products produced by Intel, this is a material risk.
RISK FACTORS (Cont’d)
INDUSTRY SPECIFIC The major industry-specific risks that INTC faces include:
Economy. While the overall global economy appears to be improving, uncertainty still remains. Since product cycles and other cyclical dynamics are typically large drivers of semiconductor growth, a weaker-than-expected global economic pickup could negatively impact the sector.
Inventory Cycle. Since the semiconductor industry is cyclical in nature, semiconductor companies are prone to periods of excess inventory and periods of inventory shortages. Such swings can have a dramatic impact on semiconductor companies relative to fundamental trends in the broader marketplace.
Product cycle. The semiconductor industry does not currently have a clear product driver. The industry is no longer a single-product (i.e., PC) industry, which means there could be breakouts and recoveries in specific sectors and not the industry as a whole. Slowing end user demand. The industry’s two largest end markets are computing and communications. Without innovation, replacement cycles may remain weak and growth could be uncharacteristically slow.
Value add. During the PC era of semiconductor growth, much of the value add came from the semiconductor companies. Accordingly, profitability for the industry in the 1990s was materially higher than the 1980s. As the industry growth shifts from the corporate PC driven growth to more consumer computing, consumer devices, and communications devices, it’s likely that semiconductor companies will not be the key differentiator of the products. Therefore, there is risk in the fact that the value add, and corresponding profitability, may shift from the semiconductor supplier to the equipment manufacturer.