Intel Is an Undervalued Blue Chip

Despite all the macro uncertainty, the chipmaker could be one of the best investments in a market with few free cash flow generating alternatives that are not already valued very highly.
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Intel  (INTC) - Get Report went into its Q1 2020 results with high expectations baked into its share price as its valuation increased by nearly 30% since the lows of March.

Even though Intel delivered against those high expectations, the second half of 2020 is looking unimpressive. Having said that, there’s no question that from the investors' perspective there’s already too much bad news factored into its valuation which trades for less than 12 times trailing earnings.

Intel is a strong free cash flow company and is well worth considering. Here’s why:

Very Strong Q1 2020 Results

The majority of Intel’s Q1 2020 results were extremely strong. The company’s data center segment, which makes up 51% of its total revenue, grew 34% year-over-year. Also, given our current work-from-home and online learning demands, PC sales soared and were up 14%. This all combined for Intel’s EPS beating expectations and reaching $1.45 EPS (non-GAAP). Meanwhile, Intel’s free cash flow was particularly strong, up 76% year-over-year to $2.9 billion.

Intel’s unimpressive Q1 results last year played a strong role in making comparisons this year look that much stronger. Furthermore, Intel’s Q1 2020 benefited from our new normal and it could be argued saw some revenue pull forward from later this year.

Some Blemishes In the Results

The one aspect of the results that took a sharp reversal from 2019, was its Internet Of Things Group (IOTG) segment, which after finishing 2019 up 11% year-over-year, proceeded to take a sharp reversal and finish Q1 2020 down 3% as industry and retail revenues started to shut down operations. However, this unit accounts for under 5% of Intel’s total revenue and is not a huge driver of its prospects.

One meaningful and questionable area for Intel is the expected trend in profitability. Intel’s operating margin in Q2 2018 was 33%, then fell to 31% in Q2 2019. Looking out into its Q2 2020 guidance, its operating margin is now coming down slightly to approximately 30% (all figures non-GAAP). Even accounting for the likelihood that Intel is being conservative with its guidance, Intel profit's margins aren't trending in the right direction, particularly given Intel’s strong Q1 2020 results where its data center shone strongly.

The main reason for Intel’s profit margin contraction is likely to be that AMD’s  (AMD) - Get Report fierce competitiveness. Accordingly, some market analysts believe that Intel is going to struggle in 2020 as its data center chips are too expensive compared to AMD’s product line-up, and Intel’s only option may be to drop the prices of its data chips in order to increase volume and retain market share.

An Attractive Valuation

Putting aside what is likely to be a choppy 2020 for practically all companies, Intel continues to generate strong free cash flow. By some estimates, Intel will have a middling Q2 2020 results with revenue growth of 8%. But as Intel progresses further in 2020 and early 2021, it will be reporting contracting revenue growth rates. At the steepest point, Intel’s Q4 2020 is expected to be particularly challenging and contract by nearly 14% compared with Q4 2019.

However, that side of the narrative is already factored in many times over into Intel’s share price given that its stock presently trades for less than 12 times earnings and less than 19 times free cash flow (both twelve months trailing metrics).

Intel’s balance sheet remains strong, with a net debt position of just under $20 billion, which given Intel’s free cash flow profile of generating nearly $14 billion over its trailing twelve months, shows that Intel could pay back all its debt in under 24 months if it were so inclined.

The Bottom Line

Near-term PC demand has increased due to work from home and online learning demands, but the second half demand picture is more uncertain. But Intel is cheaply priced at less than 12 times trailing earnings. Therefore given its ability to generate strong free cash flow and its 2.3% dividend yield, despite all the macro uncertainty, this could be one of the best opportunities in a market with few free cash flow generating alternatives that are not already valued in nosebleed territory.