If you follow Intel (Nasdaq: INTC), you know about its fourth quarter by now. The company topped expectations when it reported $7.2 billion in sales, up 3% from last year's fourth quarter. It earned $1 billion in net income, up 108% year over year, and $0.16 per share, up 129% year over year.
For 2002, sales were $26.7 billion, up slightly from 2001, while net income and earnings per share rose 140%. At $17.50, Intel trades at 38 times trailing earnings of $0.46 per share.
You may also know that the company is cautious about 2003. Management doesn't know when sales will significantly rise again. In fact, this year its capital expenditures (the purchasing of new chip equipment, etc.) will decline to about $3.7 billion from last year's $4.7 billion.
It's funny. Last year, analysts complained that Intel was spending too much on capital expenditures. Now that it's spending less, they are complaining that it isn't spending more. Personally, I'm glad to see less spent this year. Free cash flow should improve again, and what Intel is spending on (300mm wafer production) will increase manufacturing efficiency.
Overall, Intel is positioned to have another year that feels similar to last year (sluggish), while earnings are expected to rise about 35%, and free cash flow will likely rise more than that.
We don't have a year-end cash flow statement yet, but as of September 28, 2002, it had $4.1 billion in trailing free cash flow. The stock is priced at 27 times that cash. It also trades at 27 times 2003 earnings estimates.
Intel appears fully valued. Its valuation multiples are not outrageous, but they are high enough to account for an eventual rebound in earnings growth. So, I think the larger question is, is Intel worth owning?
Keep it or throw it back?
You keep an investment because you believe it will appreciate in value at a rate greater than other, sometimes safer alternatives, be that an index fund, a CD, or another stock. In our case, we want our stocks to outperform the S&P 500 index.
In the last decade, Intel handily surpassed the index. The question is, will it the next decade? Pondering this riddle, we can't just point to 1996 through 2000, and say, "Look what this company can do!" Nor can we fall victim to the "recency effect" and only remember 2001 and 2002, saying, "What a faltering business." We need a middle ground.
Consider Intel's operating income, free cash flow, and other figures the last eight years:
Year Oper. inc. FCF OCF PP&E
2002 $4,382 4,132* 8,768* N/A
2001 2,256 1,345 8,654 7,309
2000 10,395 5,266 12,827 6,674
1999 9,767 8,225 12,134 3,403
1998 8,379 5,475 9,447 3,557
1997 9,887 5,283 10,008 4,501 1996 7,553 5,523 8,743 3,024 1995 5,252 350 4,016 3,550 (numbers in millions, so, $4.382 billion in 2002 oper. income) PP&E = property, plant, and equipment spending *for year ended Sept. 2002
It saw a steady, six-year rise in operating income until the roller coaster dropoff of 2001. Despite a steep decline in demand, though, Intel was able to achieve free cash flow and stay profitable for its 15th straight year in 2001.
Then in 2002, with the economy still suffering and with most tech companies wallowing, it saw a sharp rebound in operating income and free cash flow. I don't think I can name any other old tech giants that achieved quite the same rebound (doubling earnings) last year.
Now consider the last 14 years of sales, cost of goods sold (COGS), and gross margin.
Sales* COGS* Gross Margin
2002 $26,764 $13,446 49.8%
2001 26,539 13,487 49.2
2000 33,726 12,650 62.5
1999 29,389 11,836 59.8
1998 26,273 12,144 53.8
1997 25,070 9,945 60.3 1996 20,847 9,164 56.1 1995 16,202 7,811 51.8 1994 11,521 5,576 51.7 1993 8,782 3,252 63.0 1992 5,844 2,557 56.3 1991 4,779 2,316 51.6 1990 3,921 1,930 50.8 1989 3,127 1,721 45.0
*in millions
One of the largest variables in Intel's business is average selling prices (ASP). Computer processor prices fluctuate as they trend downward. The rest of Intel's expenses, excluding capital investments, remain fairly steady in proportion to sales. Therefore, gross margin is a good measure of its profitability levels on any particular year.
In the last two years, gross margins were at levels not seen since 1995 and 1989. Gross margins toppled in 2001 as Intel cut prices to spur demand in "the worst environment" management had ever seen. If that was as bad as it gets, though, then we're onto something good here. If a 50% gross margin and a few billion in free cash flow is a bad year, we really look forward to the good years again.
And this is where I think I find my middle ground, and peace of mind, with my existing investment in Intel. In the two most difficult years that tech companies have faced in modern times, it stayed well above water. Sales didn't plummet; they merely dipped. Operating income tanked the first year, yes, but it rebounded sharply by only the second year. Management adjusted. Plus, free cash flow kept flowing, even as billions went into capital expenditures.
This company is too dominant worldwide, and operates in too important and necessary an industry, for even a once-in-a-lifetime (perhaps) boom and "bust" cycle to derail its profitability. That should mean that now, at 27 times free cash flow, it's most likely to stay stable and eventually rise again.
Near-term catalysts
I'm content to own Intel and wait a few years, or longer, for the business to grow again. I believe it will continue to outperform the S&P 500 because it is by far a company superior to most. But for the near-term junkie in all of us, what might happen sooner?
A few things could push sales higher. First, the age of the "installed" computer base in corporate America is, like all things, growing older. Sales soared in 1999 and 2000. By the end of this year, many companies may start updating their computers.
Secondly, Microsoft (Nasdaq: MSFT) has decided to end support for Windows 98 and NT 4 on June 30. This could spur many people to purchase new machines (because we all know buying a whole new system is easier than upgrading your Windows software).
But it's the long term that counts, and I believe Intel is positioned to remain a long-term market outperformer. We'll see. As of Jan. 15, 2003, Intel's market cap: $116 billion. The S&P 500: 918. Let the race begin. Again.
Jeff Fischer is a senior investment analyst for the Motley Fool, so he also writes in The Motley Fool Select. This month's issue details a consumer brand company on the rise, and a $7 biotech stock awaiting important news in March, among other stock picks. Give Select a free try. Jeff owns shares of Intel, as shown via the Fool's disclosure policy.
