Intel: Buy The 8%+ Dip

Summary:

• Intel stock fell over 8% due to the updated disclosure about its foundry business.
• The dip reflects near-term market reaction and presents a buying opportunity for investors who have an investing timeframe of 3-5 years.
• Analysts expect EPS to grow at a CAGR of 20%+ in the next few years.
• I see such a growth curve as very plausible thanks to a range of catalysts.
• The top ones are the recent $8.5B cash grant from the Biden administration, secular demand for semiconductors, and margin expansion potential.

Intel fell more than 8% in one day

The stock prices of Intel (NASDAQ:INTC) fell by more than 8% yesterday, Apr. 3, 2023 (see the chart below). The main reason for this sizeable dip is the company’s updated disclosure about its foundry business. In the disclosure, INTC reported that:

[T]he foundry business had an operating loss of $7B on revenues of $18.9B for its Foundry business in 2023, wider than the loss of $5.2B recorded in 2022 on $27.5B of sales.

Against this backdrop, the thesis of this article is to argue why the dip reflects near-term market reaction and presents a buying opportunity for investors who have an investing timeframe of 3-5 years. Indeed, the company faces several headwinds in the near term and its recent results leave much to be desired. As seen in the chart below, consensus expects an EPS of $1.36 only for FY 2024. I see the reasons for such a tepid view. The key concerns in my mind are its data center and AI segment, which are likely to decline at a double-digit clip judging by the inventory data (more on this later) for the next few quarters.

However painful the next few quarters might be, I believe INTC will turn the corner soon, and many Wall Street analysts seem to share the view as shown by their consensus estimates below.

To wit, they expect Intel’s earnings to grow at a whopping 70%+ rate YOY in 2025. And for the next 4 years between 2025 and 2028, the compound annual growth rate (“CAGR”) is projected to be 24%. By FY 2028, its EPS would reach $5.49, implying a single-digit FWD P/E of only 7.35x by then.

Next, I will argue why such a growth curve is plausible and its implications for INTC’s investment returns in the next 3-5 years.

$8.5B support from the Biden Administration

My approach to estimating its growth rate forward will be based on its reinvestment rates (“RR”) and its return on capital employed (“ROCE”). I will start with the former. As seen in the chart below, INTC invests heavily in growth capital projects, especially in recent years with its foundry initiative. Intel’s capital expenditures totaled $25.75 billion on a TTM basis, slightly below the peak of ~$28 billion about 1 year ago. On average, my estimate is that INTC has been maintaining an RR of about 20% in recent years.

Going forward, I expect an even higher RR thanks to the support from the Federal (mainly via the CHIPS Act) and local government. Recently, it has just received an $8.5 billion cash award from the Biden administration. More details are provided in this Yahoo! news and the key points are summarized below (slightly edited by me):

Intel CEO Pat Gelsinger has spent the last three years lobbying Washington to make billions available to American chipmakers, and on Wednesday, Mar 20, that paid off for his company with news of up to $8.5 billion in US grants in the years ahead… The deal announced Wednesday includes government loans of up to $11 billion. The chipmaker is also set to claim a new tax credit on its capital expenses that could add tens of billions more to its bottom line in the years ahead as Intel focuses on manufacturing capacity to produce its most advanced chips.

The $8.5B cash grant is more than 1/3 of INTC’s current annual CAPEX budget. Together with the loans and tax credits, I expect its RR to be boosted by at least 25% in the next few years, to be around ~31.25%.

Growth and return prospects

As for its ROCE, INTC was able to maintain a historical ROCE averaging around 60% until recent years (when AMD and NVDA began to claim technological lead on key products). Its ROCE has dropped to about 40% in the recent 2-3 years according to my analysis as shown in the chart below. I think its various initiatives both on the chip and found front could help to boost the ROCE in the years to come. For the foundry initiative alone, INTC is “targeting non-GAAP gross margins between 35% and 40% between now and 2030. Moreover, considering “the importance of extreme ultraviolet lithography, especially for Intel 14A”, there is a good chance that the gross margin could be even higher to be in the 40% to 50% range.

With these catalysts, I am projecting a ROCE recovery of 50% – still below its historical average and also below peers like TXN and TSM (whose historical average ROCEs are in the 60% to 70% ranges). But even with such a partial recovery, the stock could sustain a growth rate of more than 15% (50% ROCE * 31.25% RR = 15.6% growth rates). It is lower than the consensus estimates of 24% CAGR. I always like to err on the side of being conservative. Plus, a 15.6% growth rate is more than sufficient to drive terrific returns at an FY1 P/E of 29.5x and FY2 P/E of only 17.4x. At these P/E ratios, the earnings yield would be in the range of 3-6%. Combining such earning yields with the growth rates points to a total return potential of up to 20% per annum.

Summary of risks and final thoughts

To recap, there is no denying that INTC is facing several headwinds in the near term. The EPS is most likely to suffer a large drop in FY 2024 and the foundry initiative won’t contribute meaningfully in the near term. As aforementioned, judging by the inventory data (see the next chart below), the softened demand in key areas such as data centers is likely to persist for longer. According to the data in the chart below, Intel’s days of inventory outstanding (“DIO”) currently sits at 136 days. It is the highest level in the past 4 years. The issue is not specific to Intel and is industry-wide. As seen, AMD’s DIO currently sits at 121 days, which is also the highest level in the past few years. I do not expect the next expansionary phase to start for INTC (or the sector) till they first clear the inventory hoarding.

However, looking past these immediate issues, I see a compelling investment opportunity for the next 3-5 years. The company is making significant investments in expanding its manufacturing capabilities through aggressive CAPEX spending. The government’s (both federal and local) support and the secularly growing demand for semiconductors add further certainty to these large capital projects. As such, I believe INTC is well-positioned to materialize analysts’ forecasts for its rapid EPS growth over the next 4-5 years, which is very likely to lead to outsized share price appreciation.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of INTC either through stock ownership, options, or other derivatives. 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.

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