American Champion: Why We Believe Intel Has a Bright Future

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Intel Corp.'s (INTC, Financial) history can be traced back to the founding of the semiconductor industry itself – you can find its origins in Fairchild Semiconductor and the origins of Fairchild in the Shockley Semiconductor Laboratory way back in 1955. The company has been a pillar of Silicon Valley since inception and remains that way today. Recently however, Intel has lost its way. The first sign was the cessation of the mobile and other low-power markets in the early 2000s to ARM (ARM, Financial); the second, the failure to keep up with Taiwan Semiconductor Manufacturing (TSM, Financial) in advanced process node manufacturing; and the third, the belated entry into GPU and, with that, the lack of meaningful benefits accruing from the artificial intelligence boom currently underway. The stock has been duly punished. Between March 2021 and September 2022 – just 18 months – the stock lost almost 80% of the price value created from the 2009 lows to the 2021 highs – a period of 12 years. Quite remarkable. At this point, the stock was predictably written off by many observers as yesterday's news, takeover fodder and so on and so forth.

We beg to differ. We believe Intel has a bright future and, moreover, that the stock can regain and surpass those 2021 highs within two to three years.

The carrier wave

In our recent note, "The Long Bull Market to Come," we noted that the "carrier wave" of market strength is, at its core, government activity – specifically credit creation, monetary and fiscal stimulus. We believe these establish the liquidity conditions and psychological confidence needed for markets to rally. Expansionary policy – markets up; contraction in D.C. – markets down.

We think something similar lies beneath Intel stock at the present time. As you know, semiconductor design and manufacturing is at the heart of the trade war between China and the U.S. right now. In fact, "trade war" doesn't really encapsulate the play here – it's not about mutual tariff-setting, which usually just enriches governments (who collect the tariffs) at the expense of consumers and producers (who have to pay the tariffs). The play in semiconductors is about who gains maximum strategic advantage in matters commercial and military from the restricted sale of designs and manufactured devices from one territory to the other. The growth of the "fabless" semiconductor model, which has prospered since the early 2000s – not least because it means new, young chip companies can set up without the towering amount of capital expenditure needed to actually manufacture their own devices – has led to concentration of manufacturing capacity in a handful of players. Modern semiconductor fabrication is so capital intensive that such concentration is inevitable. There are now truly few companies than can manufacture advanced devices at scale, at high manufacturing yields and acceptable costs. The two leaders in IC manufacturing are Taiwan Semiconductor and Intel. And since Intel's capital base and the majority of its manufacturing plant is firmly under the aegis of the United States, Intel is at the sharp end of the trade war. If the U.S. is to win the semiconductor war with China – if it is even to maintain a lead – then Intel has to prosper. It has to resolve its manufacturing difficulties so that the move to each new process node is as seamless as Taiwan Semiconductor makes it look and it has to be able to deliver on price, on time to its fabless customers. At the same time, Intel needs to remain competitive in the CPU market and win back some market share from Nvidia (NVDA, Financial) and Advanced Micro Devices (AMD, Financial) in the GPU and AI market. None of this is easy – which is why you see Intel burning colossal amounts of cash right now – but we believe that the combined effort of the new CEO's skills and the support – the carrier wave – from the U.S. government – will get it there.

In short – if the U.S. is to prevail versus China in the semiconductor war – and we believe it will – then so too must Intel prevail – and we think it will.

Let's look at the numbers up to and including the most recently reported quarter. (The company prints its third-quarter of 2023 on Oct. 26.

Inetl Fundamentals – Source, Company SEC Filings, YCharts.com, Cestrian Analysis

Let's run through the key lines here.

• The decline in revenue is slowing. The last time Intel posted any revenue growth on a quarter versus prior-year quarter basis was the December 2021 period. Since then, revenue growth has been negative, with a low of –36% in the March 2023 quarter. June saw a decline in the drop, with a -15% year-over-year growth rate posted. The company guided to a further reduction in decline, meaning it guided for the third quarter to be down “only” 13% on the same period in 2022. This is hardly exciting news, but a decline in growth if it continues means flat revenue is not so far away, whereupon the company can start to think about growing once more.
• The gross margin has suffered terribly in the decline, from a recent peak of 57% in June 2021 to a mere 38% in June 2023. By comparison, Taiwan Semiconductor, which only provides manufacturing services and which has no gross-margin-enhancing own-brand products to sell, is delivering high 50%s gross margins today, down from a 60% recent peak.
• Trailing 12-month Ebitda margins are down to 14%, from a recent high of 51% in the June 2020 quarter.
• Trailing 12-month unlevered pretax free cash flow is heavily negative at –43%, which is driven directly by the huge quantum of capex that the company is putting to work ($27 billion-plus in the last 12 months). This capex is predominantly a result of the carrier wave logic about – new fabrication plants capable of working at smaller process nodes and higher yields than has previously been the case. The capex won't last forever, at some point it will slow up, but there is no point wishing it would go away in our view – the whole basis the stock has to move up is rooted right there in that capex.
• Net debt remains modest as a multiple of trailing 12-month Ebitda – 2.5 times - but clearly it is a big number relative to those negative cashflows.

Valuation

INTC Valuation Analysis – Source, Company SEC Filings, YCharts.com, Cestrian Analysis

Can you justify buying Intel stock when the company is chewing through this much cash? We believe you can. The 2.9 times trailing 12-month revenue, when revenue growth is likely to improve, isn't terrible, and 21 times trailing 12-month Ebida when TTM Ebitda margins are around one-third their usual level is also not too bad.

The real story, though, is, we believe, told by the stock chart.

INTC Stock Chart – Source, Cestrian Analysis, TrendSpider.

Intel looks to be under heavy accumulation in the range of $24 to $34 per share, and we name this range our "Accumulation Zone" accordingly. This is where we believe the stock can be piecemeal built into a larger position over time. We anticipate that good news stories about Intel will soon be in vogue, attracting late money who may buy in the Markup Zone we show above. Distribution by institutions is some way away we believe. We believe the stock can reclaim $40 per share without too much difficulty, then push on up to $47 before it starts to encounter material resistance from the unsold inventory of stock lurking up there at that price.

We rate Intel at Accumulate and hold long positions in the stock in staff personal accounts.

Cestrian Capital Research, Inc – 23 October 2023.