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Why I'm Much More Optimistic On Intel

Summary

Intel is well positioned to grow in the second half due to seasonal factors and product refresh.

This implies that the PCCG could balance out to 0% growth with other business units and integration of Altera into revenue/earnings providing upside.

With these factors combined I'm anticipating revenue growth of 4.38%, net income growth of 2.79%, and EPS growth of 9% for FY 2015.

Therefore, I'm re-initiating my buy recommendation and $36 price target.

Intel (NASDAQ:INTC) has had a pretty slow start to the year given the fact that PC volumes were anticipated to be weak when compared to prior years. However, I anticipate that these trends will likely improve going into the back half of fiscal year 2015 based on confirmation from management guidance, which gives me enough comfort to raise my price target and reinitiate my buy recommendation.

Interestingly enough it seems that the high-end of the PC market is still a very robust market as it contributes significantly to Intel's annual revenue. At least according to the Citi 2015 global technology conference, the tower PC segment alone contributes $10 billion in revenue, which is approximately 20% of Intel's revenue.

This particular market segment is likely to improve given the fact that Intel is expected to ramp up production for the Skylake series processors. Of course, expectations aren't necessarily going to be that high, but that doesn't change the fact that if Intel is able to maintain flat revenue in the PC client group, the data center group will sufficiently drive revenue growth in fiscal year 2015, which will significantly improve the share price going into back half of 2015. This would be a divergence in five-year growth trends, as it's been exceedingly difficult for Intel to breakout of $60 billion in annual revenue.

Intel believes that its next high-margin category will be two-in-one PCs, which is basically a tablet and ultrabook combination. This is mostly driven by the higher average selling price. Volumes in this specific segment is improving at a pretty steady pace, and that's another factor to why PCCG could go from negative 5% to 0% growth in the current fiscal year.

Furthermore, Intel believes that it can continue to innovate inside of the PC segment, by eliminating wires, passwords, and integrating interaction via alternative inputs. Going forward it's highly likely that PCs will become more powerful, and will be much more intuitive to use based on hand gestures, touch-based interaction, and virtual reality.

Going into the financial analysis part, the assumptions on growth really change in the current fiscal year assuming Intel is able to integrate the Altera acquisition, and is also able to generate 0% year-over-year comps for the PC client group. On a consolidated basis sales could grow by 4.38% year-over-year, which is partially driven by $2 billion in incremental revenue from Altera combined with $2 billion in revenue growth from the data center group. The gross margin should slightly move higher as the growth segments have slightly higher margins when compared to PCs in general. Furthermore share buybacks will reduce the share count by 160 million shares to 165 million shares based on my run rate calculation. Therefore when combining all of those factors EPS growth could surprise analysts as I anticipate EPS to grow by 9% year-over-year.

Source: Alex Cho

Of course, there could be some challenges to these expectations on earnings going forward. For starters, the PC client group would have to grow pretty robustly to offset the weakness in the first half of the current fiscal year. On the other hand, seasonal factors lead to sequential growth regardless of broader macro factors, which helps to offset some of the negative impact earlier in the fiscal year. So if Intel is able to grow 5% year-over-year in the back half of the year that would equally offset a 10% decline in revenue in the first two quarters of the year when pertaining specifically to the PC client group. The PC client group shouldn't experience issues when pertaining to supply, as there's a lot of capacity left to reach optimal demand it in the event demand proves to be relatively robust in the second half.

Furthermore, I anticipate the data center group to continue to grow at a 15% annualized rate, as many of the new business categories that were mentioned earlier in the year at the data center day will not impact fiscal year earnings or revenues until fiscal year 2016 and 2017. Therefore my expectations when pertaining to other business segments is also fairly muted. However, this doesn't necessarily mean I am pessimistic as the expectations are set extremely low, which sets the stock up for much more upside.

The stock has declined in the past six months, however it is starting to recover in light of improvement in broader macro related sentiment, and also because the business fundamentals are relatively strong when compared to expectations that were set earlier in the year. Therefore, I feel much more comfortable when forecasting upside in my price target due to the fact that there could be added momentum in terms of earnings multiple expansion and also in terms of earnings related growth as well.

With only three months left in the year I think that it's fair to say that there's very little time for the stock to reach my price target, however I feel fairly confident that the momentum will be relatively strong and will offset year-to-date losses. Therefore I am initiating a price target of $36.02. This implies that there's approximately 24% upside from current levels. Of course, I know that Intel is a Dow component stock, and for that rate of return to be reached, the stock would be generating significant alpha relative to the broader market. I'm also aware that the odds of finding a blue chip gem are rare, but with the stock trading at a healthy valuation and growth assumptions that have not been factored into the broader market consensus, the stock is trading below fair value, and will eventually trade at the price I'm targeting.

The upside is high and further downside risk seems fairly minimal, which makes it a very compelling buy.


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