This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense and which ones investors should act on. Today, we're focusing on tech, and semiconductor tech in particular, as Irvine, Calif.-based investment banker Ascendiant Capital places two big bets on AMD (AMD 1.33%) and Texas Instruments (TXN 0.25%) -- but one even bigger...
Bet against Intel
It's not often you see an analyst clamber out on a limb and tell everyone to go out and "sell" a stock -- much less a stock as big, and as well-respected, as Intel (INTC 1.77%). A sell recommendation can imperil access to management, and the insight that helps an analyst make good guesses in the future. And the very fact that most analysts tend to stick to buy and hold recommendations means that those few analysts who break from the herd are often a lonely bunch -- uncomfortable.
And yet, that's just what Ascendiant Capital did this morning: It told investors to sell Intel. As related on StreetInsider.com this morning, Ascendiant argues that "given the declining PC market, a peak market share, lack of success in tablets, declining investment in wireless, and rapidly growing capital intensity," Intel's profit margins are under pressure, and this pressure is "likely to continue." Meanwhile, revenue is also at risk, given that "at 84% of the computing market and 96% of the server market, we don't believe Intel's market share has anywhere to go but down."
This is the kind of advice that could earn an analyst some enemies. It also happens to be right.
Granted, with a P/E of only 13.1, Intel doesn't look expensive. The problem is, Intel appears to have maxed out its prospects for growing the "E" in that equation. Earnings -- profits -- have declined for the past two years, and while free cash flow is currently above reported GAAP profits, it's basically flat against FCF from three years ago. In short, no growth.
Analysts on average agree that Intel will probably find some way to achieve some growth in the future, of course. But the consensus is that long-term growth rates at Intel won't exceed 5%. While it's entirely possible that Intel's robust 3.7% dividend yield will keep the stock from falling too far (as stock prices fall, dividend yields rise), I don't see much chance for the stock to rise in value unless and until Intel finds a way to get its growth out of the single digits.
As long as analysts agree that's not in the cards, there's little reason to buy Intel -- and maybe good reason to sell.
You want growth? AMD's got growth! (Maybe.)
At the other end of the growth scale from Intel lies archrival AMD, a stock that Ascendiant now recommends buying, and a stock that -- according to analysts tallied by Yahoo! Finance at least -- will grow its earnings at a barnburning 56% annualized over the next five years. (Other data sources suggest growth will be more moderate, with S&P Capital IQ, for example, positing an 11% growth rate.)
Which of these two suggested growth rates is the right one? It really doesn't matter, because with AMD currently losing money, any rate of "growth" of profits is entirely speculative. Trailing-12-month numbers show that there are no profits to grow and no free cash flow, either, because last year, AMD actually burned through $232 million in negative free cash flow (a cash loss nearly three times as big as its reported GAAP loss). And, of course, with no money coming in the door, AMD pays its shareholders no dividend.
And this is why, although I agree with Ascendiant on Intel, I'm forced to disagree about AMD. The analyst is betting on a turnaround as AMD moves away from PCs and toward mobile devices. But the way I see it, no profit, no reliable growth predictions, and no dividend all add up to no reason to buy the stock.
Should you mess with Texas (Instruments)?
The other big semi-name that Ascendiant likes is Texas Instruments -- and if truth be told, there's more to the buy thesis on this one. Ascendiant praises TI's "management team, its willingness to be pragmatic and disciplined regarding what products/end-markets to be involved in and how many resources to dedicate to those markets." The analyst also likes the company's "significant earnings power and an unusual stability, where the company's revenue and earnings are likely more predictable today than at any period of its past."
Such predictability can be a double-edged sword, however, because it means we can have more confidence that analysts' estimated 10.8% earnings growth rate at TI is probably correct.
This is a problem because, although TI boasts superb free cash flow of $3 billion (37% ahead of reported earnings), on a $50 billion stock that only works out to a price-to-free cash flow ratio of about 16.7. This means the stock is much cheaper than its 25.5 P/E ratio makes it appear -- but still too expensive for its modest -- and "predictable" -- growth rate to justify.
Long story short, while I believe Texas Instruments is certainly the best value of the three stocks that Ascendiant initiated coverage on this morning, it's still not cheap enough to buy.
