Intel Corporation (NASDAQ:INTC) is a market leader with more than 90% share in the microprocessor industry for both desktop computers and server systems. Being very strong in this segment, the company was trying for the last several years to break its way into mobile platforms market but didn’t succeed. Now INTC is undergoing a large-scale restructuring program and aims to increase share of cloud computing and Internet of Things products in its portfolio. Meanwhile even the established “traditional” microprocessor business offers attractive returns for such a low-risk company.
INTC has a very strong and solvent balance sheet. The company has low leverage (Debt/Equity equaled modest 0.47x, Net Debt/EBITDA = 1.4x at end-2Q16) although it grew due to the 2015 acquisition of Altera, a leading provider of field-programmable gate array (FPGA) technology for $14.5bn ($9.5bn of which were raised through additional debt issuance). Some concerns on the balance sheet are caused by a large share of goodwill (15.5% of total assets) and intangible assets (9.9%). It’s understandable that a company operating in the hi-tech industry with significant R&D expenses (roughly $12bn per year) will have a large share of such assets. Still, its share of assets has grown by 10%, as intangibles and goodwill amounted to only 15% of total assets at end-FY2015, with this sharp growth mostly attributable to the Altera acquisition. This is worrisome, since it might indicate some future write-offs.
“Client Computing Group” [CCG] is the largest business segment for INTC in terms of net revenue (54.7%) while the “Data Center Group” is by far the most marginal (29.6% of net revenue) – gross profit margin for DCG equaled 87.9% compared to 51.0% for CCG. These business lines are protected by significant barriers to entry of new market participants as very large investments and significant experience are required to start manufacturing microprocessors. There are some delays in introducing a new 10-nanometer [NM] technological process, (postponed to 2017) which should be more power efficient. But the same has happened in the past for the 14nm process, and we do not expect it will have any material negative effect on INTC’s financials.
At a first glance INTC’s net income, adjusted for one-off events, as described below, is quite stable: +2% in 6m2016 YoY. But the devil is always in the details and there are surely some problems hidden within. It shouldn’t go unnoticed that in 2015 INTC combined reporting for most profitable “PC Client Group” segment and its “Mobile and Communications Group” [MCG]. What was the point behind this?
INTC chips are actively used in personal computers and server systems but not in mobile devices. At a certain point in time this became a problem since consumer demand for personal electronics started to shift towards smartphones and tablet PCs. INTC was late from the very start and since 2012 it has tried to develop System-on-a-Chip (SoC) products targeted on this segment (Atom platform), but with low success due to more power consumption than in rival products. This business was also not profitable, as tablet and smartphones manufacturers generally demand subsidies to develop devices on a new platform – so it is low-margin for component producers and can only be successful with very large scale production. In FY2014, the MCG segment reported a record $4.2bn loss with net revenue of only $0.2bn (compared to $3.1bn loss and $1.4bn net revenue in FY2013 – the reason for net revenue drop was the above-mentioned cash considerations to device manufacturers). In 2015, MCG results were reported only within the CCG segment, so we can only estimate which losses are attributable to INTC’s mobile platforms now.
In 2016, INTC cancelled two key solutions for this market, namely Broxton and SoFIA, so after four years, the company admitted its current failure in this business segment. This remains the most significant challenge and source of uncertainty for INTC – whether it will be able to take active part in fast-growing tablet and smartphone markets. Currently, INTC’s market share in mobile platforms is very low (Qualcomm (NASDAQ:QCOM), Apple (NASDAQ:AAPL) and MediaTek combined have 80% of mobile processors shipping and Samsung is closely following).
Given the unfavorable external operating conditions (mostly the above-mentioned demand shift towards mobile devices, although stagnancy in traditional computers market was also mentioned in MD&A) INTC announced a large-scale restructuring program. This led to a solid $1.4bn charge in 2Q16. The program, which entails closing some facilities and reducing headcount – currently more than 107,000 employees worldwide 3,000 of which were added with Altera purchase – is aimed to be mostly completed by the end of 2Q17. Further negative equity impact, therefore, is likely in the forthcoming year.
INTC shares demonstrate moderate beta (1.14) and quite attractive dividend yield (roughly 2.8%). The stock is now trading at end-2014 levels so effectively all the mobile failures are already taken into account by market. Any further improvements for INTC in this segment should reflect positively on stock price, as evidenced by the fact that it already trades near the 52-week high (Friday’s closing price was $37.45 with the 52-week high at $38.36). It should be noted though that the leading edge semiconductor design and manufacturing business is subject to cyclicality and the maximum downturn for 2016 was -25% of current price levels – so the stock should be suitable for investors looking primarily for stable dividend income and long-term price appreciation.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
