It has been a great run for many semiconductor stocks globally since the markets bottomed in March 2020. A pandemic driven acceleration in digitisation and supply chain disruptions, that resulted in a surge in demand combined with supply constraints, tilted the game unequivocally in favor of the semiconductor companies. PHLX Semiconductor index, a bellwether for the semiconductor stocks listed in the US, is up around 150 per cent from the March lows. Further it is up 212 per cent in the last 5 years. Many semiconductor companies have raked in the moolah. However, this has not been the case for one tech giant which has been at the core of the industry for decades and been a key contributor to its progress and evolution – Intel. With absolute returns of just 3 per cent from March lows and 32 per cent in the last five years respectively, its shareholders have been on the sidelines while others partied.
However, after years of underperformance the tide may be gradually shifting for Intel. Under new CEO Pat Gelsinger, the company is embarking on an aggressive, well-crafted turnaround strategy. At the same time, the stock trading at one year forward PE of 13.5 times, one year forward EV/EBITDA of 6.5 times and dividend yield of 3.20 per cent, is trading cheap with markets taking a wait and watch mode on the turnaround plan. This presents an opportunity for long-term investors as the risk-reward is favourable with stock hardly factoring prospects for a turnaround. A successful turnaround can lead to potentially outsized returns from current levels.
Long-term investors can accumulate the stocks on dips given the favourable risk-reward. Investors, however, need to note that the turnaround will be a long drawn process, and in the interim the markets could face pressure from likely economic slowdown due to current geopolitical and inflationary pressures. Thus, stay put for a minimum of three years.
Business basics
Intel is a world leader in design and manufacturing of semiconductor chips that power digital devices. While traditionally focussed on offerings for the PC and server industry and being a dominant player in that segment for decades, it now functions across multiple segments now. It’ product offerings span multiple industries across computing, networking, data storage and communications.
In 2021 Intel had six reporting segments, out of which four hold strong potential for the company. The largest segment is Client Computing Group, which accounts for 51 per cent of revenue and mainly consists of processors it designs and manufactures for the desktop/laptops. Intel remains the market leader in this segment by a wide margin, although it has been ceding ground to rival Advanced Micro Devices (AMD). The next major segment is the Datacentre and Artificial Intelligence (AI) Group, which accounts for 33 per cent of revenue and consists of solutions for the cloud, communications, enterprise and government segments. This will be a key segment of growth going forward as it will also drive company’s AI strategy. Together, the above two segments account for 84 per cent of revenues. The other segments while small, remain important in the long term scheme of things. One of the segments - Mobileeye, accounted for just 2 per cent of revenues but has huge potential as it is focussed on providing comprehensive solutions for autonomous driving, potentially one of the biggest trends for the next few decades. Similarly another segment which is new and small but has huge potential is Intel Foundry Services, which will focus on Intel’s plans to be a major provider of US and Europe based foundry capacity to serve global demand for semiconductor manufacturing. In the semiconductor industry, foundry refers to a factory where integrated circuits and devices are manufactured.
Underperformance over the years
After being the pioneer of the semiconductor industry since its incorporation in 1968, Intel went through a period of a ‘lost decade’ till recently as it fell behind in innovation and competitors leaped forward. The best illustration of this is in the progress that AMD, which was for a long time a minnow, has outperformed Intel over the years. As compared to Intel’s stock returns of 32 per cent in the last 5 years, AMD has returned a whopping 650 per cent.
A combination of factors have contributed to underperformance. Intel went through a period of management churn and distractions with core strategy getting muddled in the process. For example, the current CEO Pat Gelsinger, who was a key member of Intel’s core technology team from the 1980s to 2000s, left the company in 2009 after feeling ‘pushed out’ by the then CEO. In 2018, Intel’s previous CEO Brian Krazanich was forced out of the company, when it was discovered he had violated the company’s non-fraternization policy. He was replaced by the then CFO Bob Swan, who had no technology background, which resulted in poor execution during his tenure till February 2021. Intel faced severe technology related production/efficiency problems in its captive foundries, while peers such as AMD with fabless business model benefitted from the advancements made by third-party foundries.
Turnaround
Intel has embarked on an ambitious turnaround plan under its new leadership. Current CEO is focussed on taking Intel back to its roots and regaining its tech leadership. Besides accelerating processor development to bring it on par/better vs peers in areas where it is behind, Intel is also embarking on an aggressive capex plan of around $27 billion in CY22 (50 per cent jump vs. CY21 and 90 per cent jump vs CY20). The spending will be on setting up chip manufacturing plants in the US and Europe, as the company attempts to capitalise on surging demand for chips and western governments wanting some production within their borders to de-risk from supply chain disruptions. Besides being an IDM (integrated design and manufacturer as opposed to fabless), Intel also wants to tap the foundry business (new segment Intel Foundry Services expected to be a growth driver) and be a large scale manufacturer for other leading fabless chip companies.
Financials
Intel reported revenue of $75.72 billion and EPS of $4.56 in CY21. Consensus expects flattish revenue and decline in EPS to $3.50 in CY22. As per management’s recent strategy update, as turnaround progresses, revenue could grow in mid-high single digits in CY23/24 and reach 10-12 per cent Y-o-Y growth by CY26. This can revive EPS growth nicely after a dip in CY22 as revenue growth and gross margin expansion bring in operating leverage. Company has a strong balance sheet with net debt at around 2 per cent of market cap. Company’s operating free cash flows can fund its capex.
The risk an investor faces is that, turnaround plan can face bumps or may not succeed. But it appears a risk worth taking given track record of current CEO, the cheap valuation and its 3 per cent dividend yield. Further, the company also has undiscovered value – for example, Mobileeye which accounts for just 2 per cent of revenue and which Intel intends to IPO, could be valued as high as $50 billion (25 per cent of Intel’s current market cap) according to media and analyst reports in December-21/Jan-22. Even if it were to temper in current environment, it represents significant value. Thus, Intel appears a bet worth taking on if you are a long term investor.