Yesterday we wrote about the progress that Intel (Nasdaq: INTC) has made since we purchased it in 1997. We purchased Intel for reasons listed in our buy columns (see August 1997), but namely, we were enticed by the company's dominance in a growing, vital industry, and by its high level of profitability.
As you make any stock purchase, you should be aware of (and write down for yourself!) the risks that your company faces. In 1997, one of the largest risks that faced Intel was the emergence of the cheap PC. Intel was behind in this market, and even if it led, the low-end market threatened to slash profitability in the industry. Intel addressed the issues, though, and is now doing well selling low-end chips.
Today's risks differ greatly from those in 1997, so it's time -- as investors -- that we update our awareness regarding the many risks in our Intel investment. We'll be keeping these risks on our mind as we watch Intel's progress:
Capital investments are escalating. In 1997, Intel earned $25 billion in revenue and spent $4.5 billion on capital expenditures, or 18% of sales. In 2000, the company earned $33.7 billion in revenue, and spent $6.7 billion on cap ex -- 19.8% of sales. In 2001, Intel plans to spend $7.5 billion on cap ex even while sales are slowing and might be flat for the year.
Numbers show that Intel is beginning to spend more quickly on equipment in relation to sales and, therefore, in relation to its cash position. As of March 1997, Intel had $8.7 billion worth of property and equipment. Even after depreciation of a few billion dollars per year, on average, Intel ended 2000 with $15 billion in property and equipment. Over the same time, Intel's cash balance went from $8 billion in early 1997 to $13.8 billion in December.
Granted, Intel also invested billions of dollars in other companies over this period, and in share buybacks, but the trend still indicates that the growth rate in Intel's expenditures on equipment is creeping closer to the growth rate of its cash flow.
Operating income has been flattening. Intel stated that while first-quarter sales may decline 15%, the second half of the year stands to see an increase, as happens most years. In 2000, however, the second half's operating income was nearly flat with the first half ($5.0 billion in the first versus $5.3 billion in the second). If 2001 proves as difficult as some think, the second half may disappoint again.
A much larger issue is the long-term trend. Although Intel is generating huge profits every year -- and that alone has value, with or without annual growth in profits -- its annual operating income has been relatively flat since 1997. Since 1996, quarterly and annual operating income is as follows:
Intel's Operating Income ($ billions)
1996 1997 1998 1999 2000
Q1 $1.3 $2.8 $1.7 $2.6 $2.6
Q2 1.5 2.3 1.6 2.3 2.4
Q3 1.9 2.2 2.1 2.0 2.8
Q4 2.8 2.3 2.8 2.7 2.5 Total $7.5 $9.6 $8.2 $9.6 $10.3
You can see why Intel's stock had a difficult finish to 1997, and a tough start to 1998, as Intel attacked new markets. You can also see how 1999 was "strong" because it was compared to a weak 1998. Now look at the big picture. You see that 1999's operating income was even with 1997's; and 2000's operating income was only 7.2% higher than in 1997.
Intel is fighting an uphill battle to grow operating income while at the same time leading aggressive price cuts and fighting slowing sales.
Investment income is not sustainable. In 2000, Intel earned $3.7 billion from investments and this gain went into its earnings per share results. This gain compares to only $880 million in investment gains in 1999, and less than $100 million in 1998. Last year's $3.7 billion investment gain is a large reason that earnings per share rose 44% in 2000, while operating income only rose 7.2%. An investment gain is great (bravo!), but it is impossible to duplicate year after year. Investment income is not a recurring growth driver, and therefore 2000's earnings per share growth must be taken with a $3.7 billion grain of salt.
It's no wonder that earnings per share in 2001 are expected to be down about 8%. Even in a strong economy, it would be difficult for Intel to book another $3 billion investment gain to its earnings per share, or to replace that gain with increased sales.
Acquisitions bring new risks. Intel has spent billions of dollars on acquisitions and for stakes in businesses the past three years, with a focus on networking and server operations. These investments increase the risk for lower returns on investment for shareholders, should any of Intel's investments prove subpar. They also make the company more complex to follow.
In summary, Intel is financially stronger than 99% of companies in the world, and it is one of the world's most respected operations for many reasons. It isn't devoid of risk, though, and the risks are increasing rather than decreasing as the markets in which Intel operates mature and evolve. Intel's need to continually invest in its infrastructure increases the risks, too, as do Intel's attempts to grow outside its core semiconductor business. Intel is more risky than most blue-chip stocks. In accordance, if it succeeds over the long term as well as it has in the past, the rewards should be higher than with most blue chips. But investors must be aware of the risks if they're hoping for the greater rewards.
To discuss Intel, visit the Intel or Drip Companies discussion boards linked above. Fool on!
