Recent weakness in Intel (INTC)’s stock presents an excellent buying opportunity for investors. As one of March’s Most Attractive stocks, INTC offers the rare combination of strong cash flow growth with a remarkably cheap valuation. Investors were rewarded handsomely over the following 12-months the last time we highlighted INTC as one of our most attractive stocks, see interview on September 8, 2006.
Our model, which tracks performance back to 1998, shows 2010 as the most profitable year ever in terms of accounting earnings, economic earnings, and free cash flow. Return on invested capital (ROIC), which more than doubled to 31% in 2010, is the highest since 1999. The company generated $10bn, 11% of its enterprise value, in free cash flow in 2010. Excess cash is $26bn or over 20% of its market cap.
This strong performance underscores the strength of INTC’s business and the ability of its management team to allocate capital intelligently. They have made mistakes along the way, even recently with the recall of its “Core i7” chip. However, mistakes for INTC are the exception not the rule. Over the last thirteen years, INTC has generated positive economic earnings every year except for two, an accomplishment matched by only a handful of companies in the world. So, when the valuation of the stock gets super cheap, we think it is time for investors to back up the truck and load up on INTC stock.
Not only does the current valuation of INTC’s stock imply the company’s profits will never grow again, it implies they will decline by 30%. This analysis is based on assessing the future cash flow expectations embedded in INTC’s current stock price, $20.87 as of close on 3/14, using our dynamic discounted cash flow model.
Analysts who are bearish on INTC will point to the company’s recent recall of one of its new chips and the expectation for Advanced Micro Devices (AMD) to take market share as reasons to avoid the stock. They will also point to a potential slow down in PC and tablet purchases later in 2011. My response is that even if all of those things happen, it is highly unlikely that INTC will experience a 30% permanent decline in profits. It is certainly fair to expect some near-term contraction in profits especially after coming off decade-high peaks, but I think investors are foolish to expect that contraction to be permanent. Even if PC and tablet sales decelerate later this year, they are not likely to contract by 30%. It is hard to argue against the expectation that the long-term trend in devices that use chips like those made by INTC is on a strong upward trend. Computers, phones, tablets and whatever device comes next will require chips like those made by INTC. Notably, INTC recently closed its acquisition of Infineon Technologies (IFNNY), maker of the chips inside the iPhone 3GS. INTC remains one of the best-positioned and strongest companies in the high-growth-potential semi-conductor sector.
To summarize, INTC’s stock present an excellent buying opportunity at current levels because it meaningfully underestimates the future cash flow potential of the company.
INTC gets our “very attractive” stock rating because the business is throwing off a lot of cash, showing strong growth in profits while its valuation implies economic earnings will permanently decline by 305 when we see strong, long-term upside potential.
INTC fits the risk/reward profile of a great stock to buy.
For details on what causes the difference between economic versus accounting profits during the last five fiscal years, see Appendix 3 on page 10 of our report on INTC. See Appendix 4 to learn how INTC increased net operating profit after tax (NOPAT) and its NOPAT margin from 12.3% to 26.2%. INTC’s ROIC (detailed in Appendix 7) rose from 12.2% to 30.9%. INTC’s invested capital grew more slowly than revenues; so invested capital turns rose from .99x to 1.18x during the last reported fiscal year.
I have no positions in any stocks mentioned, but may initiate a long position in AMD over the next 72 hours. I receive no compensation to write about any specific stock, sector or theme.
Note: Stock pick of the week is updated every Tuesday.