Drip Portfolio Report
Monday, August 18, 1997
by Randy Befumo (TMF Templr)

ALEXANDRIA, VA (Aug. 18, 1997) -- Although I still have quite a bit of ground to cover in the analysis of OWENS CORNING (NYSE: OWC), Jeff and I are working to come to an agreement over our first purchase, so I wanted to switch the topic for a day or two in order to explain why I think dividend reinvesting into INTEL CORP. (Nasdaq: INTC) over the next twenty years makes a lot of sense.

For those of you who might reside on the moon, Intel manufactures a wide variety of semiconductor chips, including the much-ballyhooed Pentium family of microprocessors. Supplying the brains to 80% of the personal computers in existence -- likely including the one beneath your fingertips now -- Intel is a $154.3 billion dreadnought. The second largest company in the U.S. stock exchanges, Intel trails only $215.2 billion GENERAL ELECTRIC (NYSE: GE).

Intel's story is one of long-term revenue growth through increasing both unit volume and prices. This makes a wonderful combination. Sales have risen at a 30% clip since 1987, with 20% of this coming from growth in the number of personal computers sold and another 8% or so coming from Intel's ability to consistently raise prices on its products, including the central processing unit (CPU). This combination has helped to drive gross profit margin all the way from 31% in 1985 to 56% in fiscal 1996, a near double in twelve years.

Even more fascinating is the fact that Intel continues to represent a higher and higher percentage of the price of a personal computer. With the Pentium II set to be priced at around $700, it could represent as much as 33% of the price of a new computer -- up from only 5% or 10% a decade ago. Intel has even more revenue potential as the company begins to steal all of the rest of the silicon in the personal computer, as the acquisition of Chips & Technologies two weeks ago implies. Graphics, sound and Ethernet cards are all areas where Intel has a significant presence today and where the company plans on expanding in the future.

With the power to build all of this straight into the motherboard, Intel can maintain control of the product cycle and continue to ride the wave of the digitization of the world. With industry analysts calling for 150 million personal computers to be sold between now and the year 2000, assume an 80% market share and $700 of silicon in each computer and you get $84 billion in revenues over the next three years. Although some might argue that the 20-year picture is a little fuzzy and no one knows what we will be using to compute in 2017, until the day that something plays better in Peoria than the over-hyped "thin-client" or network computer, Intel's products seem very well designed for the "fat-clients" that companies like Microsoft keep throwing at the public. Even so, Intel is prepared to battle in the "thin-client" world, too, with Microsoft at its side.

Compare Intel to investor favorite General Electric and some interesting factors arise. Even though Intel has nearly twice the rate of earnings growth and twice the profit margins, the company trades at only 25 times trailing earnings, a discount to General Electric's 28 multiple. While it is hard to imagine that Intel's multiple will expand much more, the company can certainly support the 25 rating with its future growth.

Intel participates in a business with a clear, long-term future -- namely the Digital World. Using a x486 laptop a few weeks ago, I was shocked to see that running only America Online and Microsoft's Excel I was using 99% to 100% of the central processing unit's power. Although one might argue that you can do normal business applications with a x486, the graphics and speed that new high-powered applications and the ubiquitous and incredible Internet bring to the table make the upgrade cycle in Pentiums, Pentium MMX, and Pentiums IIs worthwhile to many current and future consumers.

Intel is currently the number-one central processing unit manufacturer and motherboard manufacturer. The company also holds a number of second place trophies, including network interface cards (NICs). These market positions have been hard-won and have required billions of dollars in capital spending. As a result, Intel has reduced the number of potential competitors who can produce an alternative product at the same scale to a few multinational multi-billion dollar companies like Motorola, IBM, or Hewlett-Packard, and a few select nation-states. With annual capital spending that is greater than competitor Advanced Micro Devices' entire 1996 revenues, it is hard to imagine Advanced Micro really shaving more than a few percentage points from of Intel's market share even if the company is wildly successful.

Intel has a history of sustained revenue and earnings growth that goes back ten years. That it was only this year that the company earned a 20-plus multiple to trailing earnings in spite of the fact that it has almost two times the market share of Coca-Cola is bizarre. Just because Intel has never traded at a 20-plus multiple in recent history does not mean that for some reason its history of revenue and earnings growth make it undeserving of one now.

Intel has managed to increase its return on equity over the past four years to an annualized rate of 44% last quarter, up from 30.6% in 1993. Although the initial problem with the Pentium caused a dip in 1994, it has been steadily accelerating since then. With the unprecedented length and breadth of the Pentium cycle and Intel's sustained one generation lead over the nearest competitor, the company has been able to command increasingly higher profit margins while maintaining industry leading asset turnover. The company has improved asset turns to an annualized rate of 1.0 from 0.8 in 1993 and looks to be able to continue to do so by decreasing inventories and receivables while deploying that cash sitting on the balance sheet to repurchase stock.

Intel has a long history of attracting and retaining excellent management. Although some deluded DRAM-heads believe Micron Technology is a fair comparison, it is actually difficult to find any other semiconductor manufacturer that has the kind of track record Intel has generated. Certainly one day the field programmable gate array (FPGA) companies like Xilinx or Altera or competitor Advanced Micro might claim a solid ten-year record, but other than Texas Instruments or Motorola it is really hard to say any company in the expanding industry is in Intel's class.

With the most significant risk being the hard to imagine "potential" shift to another way of computing, we think Intel makes a lot of sense for a Dividend Reinvestment Plan (DRP) investor. Sure, we could all compute with something else. But, heck, we could all drink something else as well. As no one in the '60s would have ever predicted the anti-smoking wave, who knows whether or not an anti-tooth decay wave will not make soda obsolete. There are risks in every investment, no matter what. Knowing how to weigh them is what matters. Given our standards, Intel makes a lot of sense.

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