Tuesday, December 18, 2012

SPECIAL POST ON LB'S INTEL LECTURE


The LB gave a lecture on Intel on two SeekingAlpha Boards and was not much appreciated, as one would expect. So, possibly one or two readers will appreciate this lecture series with the LB in full professorial mode. 

This is not my weekly post but a special. I am simply copying my remarks made at SeekingAlpha. 

Before venturing into the first section, imagine the following hypothetical. The owner of a business will let you buy his entire business, with a long operating history of success and a committed and talented workforce, for $1 million dollars with an average historic annualized free cash flow yield of 9.5%. Would you buy it?


(1) Intel Free Cash Flow Yield:

I am always subject to error when trying to calculate FCF yield. But I decided to give it a try nonetheless.


FCF Yield: Free Cash Flow Divided by Market Value Plus Debt Minus Cash



I start with the FCF numbers provided by YCharts:




Over the past three years ending with the Q/E 9/30/12, the average annualized FCF is $9.45 billion. 



Market Cap at $20.54=$102.18 B

+ Debt= $7.1B

- Cash + Marketable Securities = $10.465B

Enterprise Value= $98.815



I took the cash and debt numbers from the SEC filed press release for the 9/30/12 quarter:




Divide Average Annualized FCF of 9.45 by 98.815= 9.05%



See a discussion at the THEStreet on Cisco's FCF. 




The author says that any FCF yield in the 8% to 10% is a "stunning bargain"



Well, it is all about the future. The past may not be prologue. Still, I am willing to keep my position based on the sheer quality of Intel's engineers and the firm's long term proven ability to adapt, coupled with the financial resources to do so.


As I noted later on, the FCF was lowered by a bad number in the first quarter.
 I am not sure that number is accurate. 



I have not had time to figure out what happened in the 2012 first quarter using the FCF from YCharts. I am hoping that a green shade person will come to my rescue. I did see that Intel said its "cash from operations" in the first quarter was $3 billion in its SEC filed Press Release:


SEC Filed Press Release

Intel's capital expenditures will fluctuate year to year. That amount has to be subtracted. 

The net income for the 2012 first quarter was $2.738 B
Capital expenditures=2.974 B
Depreciation=1.519 B Add to NI
Amortization of Intangibles $266M




So I have not figured it out yet how the FCF got to a negative 2M



While the past is not prologue, something close to historic FCF numbers would allow me to buy this company with its own cash in less than 10 years and then keep the cash for myself thereafter. I would not need to pay myself a dividend or to buy back stock.

This is a site that gives annual calculations for FCF: Intel Corp. (INTC) | FCFF



2. Intel Data Center Group: 

Intel is already spending a great deal of money on research and development and has had success in many areas outside personal computers notably in their data center group: 

This is a quote from the 2011 10-K

"Data Center Group
The revenue and operating income for the Data Center Group (DCG) for the three years ended December 31, 2011 were as follows:

(In Millions)

2011 2010 2009
Net revenue

$ 10,129 $ 8,693 $ 6,450
Operating income

$ 5,100 $ 4,388 $ 2,289

Quote from 2011 Annual Report at page 31.

Form 10-K 

Research and development expense are high and growing:

(In Millions)

2011 2010 2009
Research and development

$ 8,350 $ 6,576

That would be a rise from 6.576B to $8.35B.

Intel is also spending FCF on adding property plant and equipment, nearly 12B this year. 

There are always issues whether or not management is spending enough resources on the next big thing (tablets, e.g.). Sometimes, a company like Intel will be ahead of that curve and sometimes behind. This is just normal. Apple does the best job of any modern corporation in staying ahead. But Intel has the resources and ability to catch up when caught behind the curve. 

While it is just my opinion, I think that investors are harping too much on the tablet issue. Intel will be there in a big way, maybe as Apple's foundry partner and/or with its own products. I own the IPAD and view it as a toy to watch Videos purchased from ITunes anywhere in the house or when I am away waiting for an appointment, etc. It is not from my viewpoint anywhere close to a functional computer for most users.

3. Intel Channel Trading Strategy: There was no interest at all in my channel trading technique. 


Snapshot of Shares as of the close on 12/18/12:

Intel Shares: Price as of 12/18/12

For anyone concerned about Intel's prospects and the potential capital appreciation return, there is a way that I normally deal with that issue. 

I am generally satisfied with a 10% annualized total return for a stock. We all hope for more, but that is my satisfaction level which certainly beats a 10 year treasury note yield. I am not the kind of investor that is the market for Amazon stock at its current price and valuation level. 

For many of my dividend stock positions, a significant part of that return can be generated by the dividend. 

One trading strategy that I frequently attempt to follow is buying and selling at predetermined prices, taking into account a stock's normal channel movement. This requires both patience and discipline.

A lot of Intel's recent channel movement is between $20 and $26 looking at a two year chart. 

Yahoo Finance:  INTC Interactive Chart 

I look at that chart channel and basically determine a possible purchase price and a price to lighten up. 

If I did not already own Intel, I would look to initiate a position below $20. I would not take the entire position at once. As shown in my blog, I acquired my Intel position consistently below $20 for open market purchases starting soon after the Lehman collapse. 

In this trading strategy, I would not add to an existing position with a market purchase above $20. I am supposed to be selling some of the odd lot shares bought on a move from $25 to $28. I failed at that task. My only excuse is that I forgot. 

The first bought open market shares was a 50 share lot at a total cost of $ 16.04 on 10/14/2008 and the next was 30 shares at $14.73 on 10/22/08. 


Since both stocks are now out of the buy range for open market purchases, I have acquired shares subsequently for GE to date and Intel through September 2011 only with dividends. Another component of the strategy is to change the dividend reinvestment option based on predetermined price levels. 

If I had been on my toes, and I was not, I should have harvested the profit on the shares with the total cost numbers of $16.04 and $14.73 when the price rose to $25 to $28 earlier this year.

If I had done what I was supposed to do in this strategy, I would have moved much closer to that 10% annualized yield than now, though I am still doing okay at my average cost, plus the dividends and the unrealized profits that I have on most of the shares bought with the dividends. 

Based on my dividend yield at my total average cost, I will not need to make that much on the shares in order to achieve that 10% annualized goal.

At 10%, money will double in 7.27 years before taxes and inflation adjustments. 

I wanted to add some color to my comments above relating to a version of channel trading that I will use. I use a variety of techniques developed over the years. The one described here is frequently used for good dividend paying stocks and is on prominent display in some investment strategies such as my regional bank basket strategy. 

My dominant strategy is to buy a wide variety of income producing securities throughout the capital structure on a worldwide basis, generating a constant flow of dividends and interest (cash flow) which are then redeployed to buy more income generating securities, creating a compounding effect over time. 

With a channel strategy, I will hopefully be generating gains on small pieces, collecting dividends and then buying on dips to replace shares previously sold. Sometimes, I may quit altogether when I end up with my lowest cost shares using FIFO accounting (e.g. buys at $10, $8 and $7 in that order, then selling the $10 and $8 at $12 and just stopping, so there are a lot of variations depending on the circumstances)

The purchases described above of Intel and GE were made with that cash flow, starting after the Lehman collapse. No matter how bad conditions become, I will invest that cash flow in what I view then as the most opportunistic short, intermediate and/or long term option known to me. That option may be an odd lot purchase of a stock, an exchange traded bond, a European hybrid, a fixed coupon or floating rate equity preferred stock, or a foreign stock based on criteria including the value of the USD. 

The following is additional color on the channel strategy:

(1) The channel strategy can be short or long term. For both INTC and GE, I am still holding shares bought since 2008. Sometimes, I will be using the channel for shorter term trades. 

GE had a different channel in 2008 than it does now. The channel for GE between June 2003 to June 2008 was mostly movement between $30 to $40. Looking at that channel, a channel strategy would have produced a buy near $30, and the Near Depression caused that channel to reform at much lower levels. 

(2) I will look at both the 2 year and 5 year charts to develop entry and exit price targets. 

(3) Adds and Sells are in small lots. 

(3) Before starting the trade, I will make a predetermined evaluation of the total amount of monetary exposure, which can be moved up or down and that level will influence the size of the lot purchases. I would have a much lower exposure limit for Intel than for KO where I am at my exposure limit based on just three purchases, but I am still under the Intel limit amount. 

The limit amount is a risk management feature. I will take more risk with KO than with INTC. I have a strategy called the Lottery Ticket Basket strategy where my limit is $300 per position plus any prior profits on that stock. That limit would be equivalent to a high risk categorization, as is the use of the basket approach with 40 to 50 securities in the basket. Some will work and others will not. 

(4) The timing of the adds and their relative size will be determined by the amount of cash flow available, other income options, and news events relating to the company. I believe that every single odd lot purchase of Intel found in the snapshot referenced above has a post explaining my rationale. I may be reacting to an earnings report, a cash flow infusion, a dividend raise or reading some report or news item that gives me more optimism. I am not that concerned about the large variation in prices, as long as the buying is below the predetermined purchase level.

The last adds for both GE and Intel were both below the predetermined stop level of $20, I believe, but went slightly over $20 with the commission costs. 

(5) Based on developments, the criteria can change on the buy and sell targets and the exposure amount for example. This strategy is not static or frozen, but can be static for a long period of time based on conditions.

(6) Discipline and patience are required. Most of the time I am doing nothing but waiting. Occasionally, error creep comes into play and I forget what I supposed to do. If I had just a few securities, I probably would not forget but In
tel and GE are just two among many.

(7) With my parameters, I am doing nothing between $20 and $25, neither a buyer or a seller. Another investor may set different parameters using this strategy and have a different time perspective. For example, the channel could be narrower (e.g. less than $22 on the buy and $24-$25 on the sell), looking for that 10% in a much shorter time span (one year for a LT gain)


The next two market lots were bought at $15.52 and $19.32 during 2009. Those would be slated for disposal, along with reinvested dividends through the last purchase date, in the $30 to $35 neighborhood. 

I will still have shares to sell. 

The decision of where to sell in those ranges will be based on then existing conditions which would include recent price momentum and volume; whether the movement had some significant technical significance (volume break above 200 day SMA); news and/or earnings. 

Proceeds would then be plowed back into Intel when and if the downside target range is achieved, possibly buying much in the same way as before, particularly if there are some fundamental and rational reason for the slide back down.

If shares earmarked for disposal had been sold, there would have been an automatic buy when and if I saw these prices:

Dec 5, 2012 19.94 20.02 19.74 19.85 45,847,000 19.85
Dec 4, 2012 19.63 20.05 19.61 19.97 57,942,400 19.97
Dec 3, 2012 19.88 19.92 19.50 19.54 50,637,000 19.54
Nov 30, 2012 19.63 19.77 19.42 19.57 51,427,800 19.57
Nov 29, 2012 19.83 20.04 19.46 19.53 64,926,300 19.53

INTC Historical Prices 

Any investor following this channel strategy could pick their own points for entry and exit on the lots. It is important to maintain both discipline and patience. 

The first steps are to identify the total amount of capital that the investor is willing to risk; the price target levels based on the two or five year chart; and the goal. 

When this strategy is used, my goal will generally be a 10% annualized total return. I do not need that return every year, but over a longer period when the channel strategy is used for long term investments (call it 5 to 10 years). Some years may be negative with the dividend. I will use it for shorter term trades too. 

Intel is in the long term category. I have now held shares purchased since 2008 with no sales. 

With the good dividend, how much do I really need on the share appreciation to achieve that goal and how do I realize it?

It would have helped to sell that 80 shares at $28 for one. 

Needless to say, when I first purchased stocks in the late 1960s, starting with HCA in Nashville when it owned one hospital called Parkview, this kind of strategy could not be used since the commissions would have strangled it at birth. In today's world, with $2 to $8 commissions widespread, that is less of a factor. 

This kind of strategy is designed for stocks like Intel. It would not be appropriate for purchasing Apple shortly after the first Ipod was released and the shares were selling at $10-$12 as I recall. 

I have a number of other stocks bought during this time period where I used the generational opportunity to buy the position, possibly in lots, but the channel approach has never been adopted or used (e.g. KO, UN, SYY and MDT, all still owned)



**************
The strategy that I outlined is not a buy all or sell all, but one based on the natural historic movement within a channel. If the stock forms a new higher channel, which many will do, I will still own shares, but I may have missed an opportunity to buy more by sticking to the predetermined buy prices at below $20. That requirement may cost both me and Mr. Smurf above money if things turn up by the way. 

The channel strategy that I outlined is premised on what I said at the beginning of that post which I reference. When I have questions about the sustainability of earnings growth, I will adopt this strategy rather than avoid the stock altogether as many commenters apparently are doing. Why? Their general reason is that it is dead money. Maybe it has been if you hang on and do nothing, but there is a trading strategy which could turn that "dead money" into a potential 10% annualized yield given the headstart with the dividend. 

I have been following Intel since 1981, which does not make me an expert given my totally inadequate tech background. That history does give me a lot of data, some of which is even remembered, to form this kind of strategy for this specific stock. One of the issues for me at least is simply the vast amount of money Intel has to spend on plant and research to stay in the game, really huge sums. 


4. Intel and Bond Investors (no one bit at this argument)

I would suggest looking at how much Intel has raised in senior note offerings and the cost of that debt, which is deductible:

There are two recent offerings:

The largest of the two can be found at the SEC:

Prospectus


$3,000,000,000 1.350% Senior Notes due 2017
$1,500,000,000 2.700% Senior Notes due 2022
$750,000,000 4.000% Senior Notes due 2032

Bond and equity investors look at the same evidence but ask different questions. I own a lot of bonds and I am just continually asking two questions. Am I going to get paid interest on a timely basis and will I get my money back at maturity. And with my junk bonds, I ask myself how much will I possibly receive when and if there is a default. 

My point is slightly different. I am stating more of an opinion than anything resembling a fact. The Intel rates are so low, and the amounts are sufficiently large, that the bond investors do not see a problem going forward with earnings. You ought to see some of my junk bonds, where there is more of a convergence in opinion.

I also made some comments to this article about Intel's FCF and dividend growth. Earnings growth certainly does look a bit unremarkable at the present, but the bond guys are looking out into the future too
$750,000,000 4.250% Senior Notes due 2042

****

Given the sheer magnitude of Intel's capital spending and research expenditures, bond investors would also care about earnings growth, particularly when lending such large sums of money over long periods. 

I am taking this point in the context of Intel spending almost $12B this year on plant and another huge sum on research and development. The bond investor wants that cushion from earnings growth when the company has such substantial and recurring expenditures. 

I can speak for myself only as both a bond and a stock investor. I am looking at the same material in both capacities. I want to see earnings growth as an investor in both securities. My motive as a bond investor is different. In that capacity, I am looking for a cushion, rather than trying to value the common shares, and I particularly want a cushion on long term bond positions to address the credit risk issues over a 30 year time span. I see the ongoing expenditures for Intel and want to be comfortable particularly at those rates


5. Intel Dividend:

I would expect the dividend growth rate to slow down, at least until there is a more positive demand for PCs. This year will probably mark the first decline in PC shipments for the past 11 years. It remains to be seen whether a low single digit level of growth can resume with more positive economic growth worldwide; IT managers becoming less fretful for the usual assorted reasons; and a Windows 8 upgrade. I do not regard the tablets as functional computers for most users. 

Intel has its dividend history going back to 1992 at its website:

Intel Corporation - Dividend Summary


6. Large Cap Multiple Compression: (in response to the frequent observations that Intel's stock has gone nowhere)

I know someone who bought Intel in 1981, not me, and held it for a long time. She showed me the return over a decade ago and it was eye popping. One decision like that one and you are set for life. Those days are gone. For Intel, it ended in the late 1990s with its share peak. Gains expectations now have to be modest with some trading on pops and buying on dips, hoping for a 10% annualized return. So, I would agree with your point up to a point. 

PC growth will at best be low single digits. I cited some data in the comments here or in the other recent article by RS showing the rapid growth in the Data Center line of business. For Intel to become a modest high grower, more product lines like that one need to be developed.

And I agree with the comments made by pearls and swine. As part of the natural cycles of long term bear and bull markets, there will be an incredibly high multiple placed on a large number of companies during the blowout phase of a long term secular bull market, such as the one starting in 1982 with the blowout in 1999. In the secular bear market that follows, which may have ended in March 2009 hopefully, a large variety of companies will continue to grow their dividends and earnings, some better than others. Yet, the market is not going to reward those companies. Years pass, more years pass and the stock goes nowhere, but the earnings rise, as does the dividend. Eventually those companies reach a single digit P/E or slightly above, which happened in 1982 and has happened again now, and will happen again and again and again. This does not mean that investors are behaving anymore rationally at a 9 P.E. than a 75 P.E. Both reactions are at their essence irrational. Efficient market theory is snake oil and hokum. 

I discuss this type of issue several places in the blog. One discussion can be found in a May 29, 2010 post at Item # 3 

Large Cap Valuation Strategy-A New Long Term Strategy

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