Semiconductors are the building blocks of modern technology and the world can't get enough of them right now. A global chip shortage began during the pandemic, and with supply chain disruptions continuing, it's still causing problems in chip-reliant spaces such as the automotive industry. Over the long term, our growing use of technology will demand more semiconductors. According to DigiTimes Research, that will push the chip market from its 2021 total value of $556 billion to more than $1 trillion by the end of the decade.
Chip giant Intel (INTC 4.09%) is investing heavily in its plans to remain a key industry supplier over the decades ahead. However, the stock has fallen by more than 50% from its high in a fearful market worried about how much Intel is spending. Is the market's pessimism justified, or does Intel offer long-term investors a potential opportunity for outsized returns?
NASDAQ: INTC
Key Data Points
Spending big money for future growth
It's remarkable how such a vital resource can come from such concentrated sources. Roughly half of the semiconductors worldwide that are manufactured by third-party foundries -- as opposed to those made in-house by the companies that design and sell them -- are produced by a single company, Taiwan Semiconductor. South Korean company Samsung is the second-largest third-party manufacturer, though it also produces its own chips. The rest of the world's supply is somewhat fractured among numerous sources. But a large number of major chip companies are "fabless" -- reliant on foundries (most of them in Asia) for their production. And that potentially leaves the United States vulnerable to further supply disruptions. The heightened geopolitical tensions with China only underline that issue.
The U.S. government is investing heavily in boosting domestic semiconductor production via the CHIPS Act, passed in 2022. It sets aside up to $52 billion to assist semiconductor companies like Intel, plus more in tax credits. Intel -- which handles much of its own chip manufacturing, but still outsources some production to foundries like TSMC -- is building more foundry capacity in Arizona and Ohio, both to serve its internal needs and to provide manufacturing capacity for other companies.
INTC capital expenditures (TTM) data by YCharts.
But Intel's ambitious plans won't be accomplished on the cheap. Its capital expenditures have skyrocketed, which is taking a toll on its finances. The chart above shows how Intel's rising spending has pushed its cash flow negative, though it does have a large cash balance on the books to help absorb some of the costs. Additionally, Intel has partnered with Brookfield Infrastructure Partners to help shoulder some of the upfront costs in exchange for some of the long-term earnings its new foundries will generate.
Short-term pain ahead?
Intel's plan seems strategically sound, but the journey could be a bumpy ride. Unfortunately, the global economy could face a recession, negatively impacting semiconductor companies like Intel. You can see below how much sentiment has turned south, illustrated by the reductions in revenue estimates from analysts. So far, Intel has followed that downward path; revenue fell 20% year over year in the third quarter of 2022.
INTC revenue growth estimate for current fiscal year data by YCharts.
Companies often batten down the hatches and cut back on spending when times get tough, but Intel is already deep into its spending plans. Falling revenue will likely stunt its cash flow, which could force management into some tough choices about how to fund its foundry plans. Currently, Intel is levered at 1.4 times debt to EBITDA, and I typically like to see companies stay under a ratio of 3. If Intel must borrow to pay for its new factories, investors should monitor the balance sheet to make sure its leverage doesn't get too high.
A monster long-term opportunity awaits
Investors who can endure short-term uncertainty could make out well over time. Intel's stock is trading at a price-to-earnings ratio of just 9, which is a notch or two below the 13 it has averaged over the past decade. Analysts agree that Intel's short-term earnings growth could be minimal, but the long term looks bright. Intel's Arizona and Ohio foundries could open sometime in 2024 or 2025, and could give the business a huge lift.
INTC PE Ratio data by YCharts.
According to the current consensus analyst estimates, Intel's revenue will come in at around $87 billion in 2025 ($69 billion trailing 12 months) and earnings-per-share (EPS) at $4.72 ($2.19 trailing 12 months). If Intel hits those numbers and the stock at that point trades back at its average price-to-earnings ratio of 13 in 2025, the share price would be around $61.36 per share. That would be a 110% price gain from its current price, plus dividends.
This is speculative, of course. Analyst estimates looking that far out are sparse, and Intel will have to successfully execute its foundry plans to hit its targets. This helps explain why the stock trades where it does today. However, one can see that Intel's business could grow significantly if it can successfully open the foundries being built right now. The potential long-term gains make Intel a rebound candidate worth considering.
