Intel (NASDAQ:INTC) stock rallied nearly 40% over the past year, easily topping the NASDAQ's 17% gain. In a previous article, I discussed two reasons Intel could decline -- its mobile "money pit" and ARM Holdings' (NASDAQ:ARMH) slow creep into servers. Today, let's take a look at the flip side and discuss three reasons Intel stock might rally over the next few years.
1. The evolution of the PC market
When tablet sales surged over the past four years, Intel was left out in the cold by ARM-licensed chips, which were considered cheaper and more power-efficient alternatives to Intel's Atom CPUs. But tablet sales are now slowing down, as demand for PCs is bouncing back.
Gartner expects global tablet sales to rise just 8% year over year to 233 million units in 2015, down from 68% growth in 2013 and 11% growth in 2014. Sales of "traditional" PCs (laptops and desktops) are expected to fall 7% in 2015, but sales of "ultramobile premium" devices like Microsoft's Surface Pro and Apple's MacBook Air are expected to soar 59% to 62 million units. This shift will be due to owners of traditional PCs upgrading to lighter laptops and hybrid 2-in-1 devices, which bridge the gap between older Windows PCs and tablets.
Since Intel CPUs power most of these devices, they will likely offset slumping sales of older systems. Gartner expects the entire PC market to grow by less than 1% year over year in 2015, then rise nearly 4% in 2016 as ultramobile premium devices take over. According to IDC, Intel controlled 90.3% of the notebook and 81.8% of the desktop CPU markets in the third quarter of 2014, keeping it well positioned to profit from those upgrades.
2. The foundry business
13 years ago, 25 companies -- including Intel -- manufactured 130nm silicon chips. However, chips became smaller and tougher to manufacture, causing the average cost of outfitting a silicon fab to surge from $2-$3 billion to $10-$12 billion over the past decade.
In response, many companies outsourced the manufacturing process to other foundries. Today, only four companies -- Intel, Samsung (NASDAQOTH: SSNLF), TSMC (NYSE:TSM), and GlobalFoundries -- can afford to manufacture today's top-tier 14 and 16nm chips. Intel has already launched 14nm chips and has its sights set on 10nm ones, putting it on par with TSMC and Samsung and ahead of GlobalFoundries, which teamed up with Samsung last year to catch up.
Unlike TSMC, Samsung, and GlobalFoundries, Intel was reluctant to manufacture chips for fabless competitors. But under CEO Brian Krzanich, who took over in 2013, Intel signed major foundry deals with Cisco and Panasonic. If other major players (like Apple) outsource their chip manufacturing to Intel, the foundry business could account for 6% of Intel's top line by 2017, according to JPMorgan. That percentage could keep rising if it steals customers away from the other foundries.
3. The Internet of Things
Intel missed a huge technological shift when it let ARM-licensed chips take over the mobile market. That's why Intel now has its sights set on the budding Internet of Things (IoT) market, which consists of machine-to-machine connections between objects.
IDC expects global spending on IoT tech to soar from $4.8 trillion in 2012 to $8.9 trillion in 2020. To capitalize on that demand, Intel established a dedicated IoT segment last July. Intel has already unveiled tiny SOCs (systems on chips) like the Quark, which can be installed in wearable devices and everyday objects.
To address security concerns about connected devices, Intel tapped into its McAfee subsidiary, now called Intel Security, to launch an IoT security platform to unify "gateway, connectivity, and security components" and streamline the deployment of IoT devices. ARM, which is also interested in licensing IoT chip designs, recently acquired security specialist OffSpark to secure its licensed devices.
Unlike its money-losing mobile division, Intel's IoT segment has been faring well. Last year, revenue at the segment climbed 19% year over year to $2.14 billion as operating income rose 12% to $616 million. The weight of the IoT business will likely keep rising as more everyday objects become connected to each other.
Intel is currently a fairly cheap income stock, yielding 2.8% and trading at 14 times forward earnings according to S&P Capital IQ. Although its stock price was fairly stagnant over the past decade, I believe that rebounding PC sales, new foundry partnerships, and rising demand for IoT solutions could eventually carry Intel to new highs.