• kennethkohwk

Updating my valuation on INTEL

Summary:


Intel just reported their Q4 and FY21 earnings. The quarterly numbers quite positive and better than analyst expected, but Intel's weaker Q122 (than some expected) guidance lead for the stock price to drop. Intel gave underwhelming guidance for next quarter of again $0.80 with tax rate of 15% (which is actually their long term average). This value seems low to some people because last year Intel paid less taxes than normal, leading to higher than usual earnings.


This is likely the slide that shook some people:


The revenues actually look great. The margins were already projected last years.


The $0.80 EPS for Q122 just looks too low compared to last year.


How do I see it?

I think it bodes well for longer term, but short term will likely be a little uncertain causing weak hands to sell.


This print of $0.80 is good for clarity, because it excludes things like share-based compensation and equity gains... and more importantly, it's based on a raised tax rate of 15% when most of FY21 Intel benefited from lower than average tax rates.


I think Intel is slightly undervalued, but its possible for short-term weakness or uncertainity as people "digest" the low Q122 EPS. Weak hands might sell.


However, when we do a proper DCF with conservative measures, we find that:


Intel is likely worth between $53-$58 with a conservative discount rate of 12% based on management longer term guidance, and this doesn't not account for the market rerating them as they become more competitive, or bonuses like their MobilEye IPO.


I think Intel under $47 (which is represents the bear case for FY22) is worth getting for a diversified portfolio.


...


The Blog Post proper:


Remember, the thesis is that they are growing out their products to get into leadership, and building out foundries in the next 4-5 years through their IDM2.0 plan.


The long term picture is encouraging, the short term picture in terms of EPS is a little uncertain because the 1Q22 EPS is lower than some expect, wondering if they can make their FY22 full implied EPS guidance.


CEO Pat Gelsinger said that during the fourth quarter of last year, Intel (INTC) saw "unprecedented demand" for its products, but that the reality of supply issues can't be ignored.

"We expect to see [product] constraints to continue through 2022 and into 2023," Gelsinger said.


Here is News Summary, my comments in BOLD.

▪ Fourth-quarter GAAP revenue was $20.5 billion, exceeding October guidance by $1.3 billion and up 3 percent year-over-year (YoY). Fourth-quarter non-GAAP revenue was $19.5 billion, exceeding October guidance by $1.2 billion. Full-year GAAP revenue set an all-time Intel record of $79.0 billion, up 1 percent YoY. (GOOD!)

▪ Delivered GAAP fourth-quarter earnings per share (EPS) of $1.13, exceeding October guidance by 35 cents. Fourth-quarter non-GAAP EPS was $1.09, exceeding October guidance by 19 cents. (GOOD!)

▪ In 2021, Intel generated $30.0 billion of cash from operations and $11.3 billion of free cash flow (FCF). (NOT BAD!)

▪ Announces five percent increase to quarterly cash dividend. (Good vote of confidence)

▪ Forecasting first-quarter 2022 revenue of approximately $18.3 billion; expecting first-quarter EPS of $0.70 (nonGAAP EPS of $0.80). (Darn! Wished this was higher, because it makes the bar for the rest of 2022 to be higher to outperform)


Parsing through their performance, there are things to be encouraged by:


Their Data Center group continues to strongly grow! Their CCG dropped, but most of it is due to the segments in there that they sold off. Their CFO gave color to the CCG going down when answering analyst questions:


"But if you take into account the fact that we -- you look at our exit of modem and our exit of Home Gateway and the impact that, that had on a year-over-year comparison, that's about 6 points of growth. And then the customer's decision to go vertical on -- a large customer decided to go vertical, that's about another 6 points. So the overall growth, the pattern is a little different because of the mix year-over-year. But the growth relative to the TAM, when you take into account these changes, is much more in line with the overall growth of the industry."


The rest of the industry is growing at single digits.


My take away is that the entire consumer computing industry is still growing by single digits and Intel will take part in that, now that they have already taken their one-off effects this year.


The Data Center looks robust and will continue to grow.


The constraint is the supply issue.


Hence, I think their longer term guidance is still more or less intact.

Interestingly, the CFO mentioned that they are comfortable with a 52% gross margin in 2022. The question is how to factor in the "weaker" $0.80 EPS in Q122. Is it going to be at this level every quarter in FY22? Or should it be growing? If we assume that every quarter will be $0.80 for the year, that's a runrate of $3.20 EPS. Or, a 15x fw PE at the share price of $50. This is highly improbable due to the factors I will list below, but this shows you a "bad case scenario". The share price may fall 20% to a fw PE of 12x, IF earnings don't increase from 1Q22, and IF the market thinks earnings won't increase for the year after.


However, considering that

1) gross margins are still to management's expectations.

2) strong demand for their products.

3) CCG and DCG looks to continue to grow.

4) Revenue will increase as their foundries become more online.


The uncertainty is mainly to the extent of the supply chain shortage.


I think it's likely that Q2 to Q4 EPS will be higher than Q1.


I modeled three DCFs with a FY22 EPS of $3.20 (bear), $3.60 (quite doable) and $3.96 (theorectically possible with management projections on revenue and margins, AND no extra increase in R&D expense.) to show you how the numbers look assuming the management guidance of revenue growth and gross margins are intact. All of which have

- a discount rate of 12% (conservative, it should be 8-10% for a blue chip)

- a terminal PE of 12x (also conservative, because if they successfully build out their foundries and prove competitive, it could rerate to 15x PE compared with 30x PE for TSMC)

- the "undervalued" or "overvalued" caluclations are based on a share price of $50.6.

- all of which has a lower starting "core" EPS of FY2021 of $4.49, that I adjusted for. It's less than management's reported non-GAAP EPS of $4.86. This is because I took into account adjustments for taxes, on top of adjustments for extraordinary items.


Now, the extreme worst case scenario is that Intel doesn't grow at all for the next few years. If so, then a 12x PE for an EPS of $3.20 implies a downside of 20% for the share price. This seems too unlikely, with all the moves they are doing today.


However, if we apply management's long term guidance (and they seem to be on point so far) on what FY22 EPS might be, we get very different valuations.


Worst case scenario, every quarter in FY22 is $0.80. So FY22's EPS is $3.20.



We see that in this bear case, the PV is worth $46.9 it's only overvalued by 7%.


If EPS improves and the FY22 turns out to be $3.60, then ...



Then PV is $52.7 and it's undervalued by 4% (excluding 2.5% dividends).


If management guidance is correct. If revenues are going to be >$74 in FY22, which they already hit $74.7 in FY21, and if gross margins are going to be 52%. Then it's possible to hit an EPS of $3.95. This is slighly based on a -9.9% drop in net profits from FY2021 EPS of my own adjusted core EPS of $4.38 which is what management's revenue and gross margin estimations imply.


By the way, you might be wondering why I have FY21 EPS of $4.38 instead of the GAAP FY21 EPS of $4.86 or Non-GAAP FY21 of $5.30 that management reported.


This is where being an ex-analyst helps.


My value is lower because I was adjusting for both extraordinary gains and losses (that gives you the non-GAAP numbers) but also to adjust for their favorable tax rates in the last few quarters (which is not adjusted for in their numbers). Their long term tax rates are 15%. So I adjusted their net incomes based on a hypothetical 15% as opposed to the lower rates they had.


If FY22 EPS turns out to be $3.95, which I think is possible if everything goes Intel's way, then...


Then the PV is almost $58 and it's undervalued by 15%.


Note that these numbers are conservative because revenues are supposed to be >$74, but I am using $74.


NOTE: The increases/decreases in net profit are estimated from the increases/decreases in gross profits based on management projections. This means that I am assuming that R&D expenses and other expenses below the gross profit line are constant.


Now, the biggest reward that is not seen in these DCFs is that if Intel executes and becomes a bigger player in the foundry space, and if they get closer to tech leadership then it should rerate.


If it rerates to 15x fw PE in 5 years, then, using the mid-case of $3.60 FY22 EPS:


It's 22% undervalued.


If it rerates to 15x fw PE in 5 years, but using the management guided implied case of $3.95 FY22 EPS.

Then the PV is $68 and it's undervalued by 35%. This would be the blue skies scenario.


Conclusions:

1) Longer term trends seem intact.

2) Intel's performance is decent, DCG grew; and CCG grew with industry if you exclude the effects from selling certain divisions.

3) the Q122 EPS of $0.80 looks bad to some, especially if you didn't factor in the lower taxes Intel paid in 2021. If you adjusted for those lower taxes, this drop doesn't look great, but at least it wouldn't be shocking.

4) This "shocking" drop might cause some selling pressure.

5) My DCF valuations show you what different prices mean:

Take a simplistic 12x fw PE based on Q122 numbers (with no further growth in 2023 too) and it's worth 20% less.

If you assume the longer term projections are still on, then:

  • At core FY22 EPS of $3.20, (unlikely bearish) it's slightly overvalued. (-7%) Target Price = $47.

  • At core FY22 EPS of $3.60, (quite doable), its slightly undervalued (+4%). Target Price = $53.

  • At core FY22 EPS of $3.95, (doable based on management projections, no increase of R&D expense levels), it's quite undervalued (+15%). Target Price = $58.

  • If Intel hits the jackpot and the market finally rerates them to 15x fw PE (or more) because they are recognized for their new competitive advantage in 5-years time, then add about another 10-to-20% upside to whatever target you have.

My 2021 EPS calculations are quite conservative, taking into account average tax rates of 15% and stripping off one-time or extraordinary gains or losses.


My 2022 to 2025 EPS calculations are based on my stripped down 2021 EPS "core" earnings using management's revenue and margin guidance.


I think Intel is slightly undervalued now, HOWEVER, I think it's possible INTEL might sell lower because it's not easy to understand these projections.


However, I think that any price under $47 is a good opportunity to pick up some. This price ASSUMEs that Intel's EPS will not grow in Q2, Q3 and Q4 of 2022 and then resumes the trends that management has highlighted. If Intel's performs better than this low bar, it's worth more than $47.


Don't forget that INTEL is a speculative value stock and should be part of a diversified portfolio.


It's value in that it's still trading between fw 10x and fw 15x PE, and has an increasing dividend. It's got lots of IP and is cash flow rich. It is in the best position to grow into the foundry business. However, everyone is watching to see how the competitive shake out will result. Intel succeeds and it's worth more with 20%-45% upside. Intel doesn't and it becomes a value trap with (-10% to -20% downside).


Final Conclusions:

I think Intel is slightly undervalued, but its possible for short-term weakness or uncertainity as people "digest" the low Q122 EPS. Weak hands might sell.


Intel is likely worth between $53-$58 with a conservative discount rate of 12% based on management longer term guidance, and this doesn't not account for the market rerating them as they become more competitive, or bonuses like their MobilEye IPO.


A drop below $47 is likely a good time to add.


Cheers!



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