On Wednesday, Intel Corp. (INTC, Financial) CEO Pat Gelsinger remarked during a panel at CNBC’s Evolve conference that he expects 10 “good years” of growth in the semiconductor industry. In response to the increase in demand for semiconductors, Intel is investing aggressively in chip production capacity, which the company believes will be used even after the current global microchip shortage abates.
Gelsinger took the reigns as CEO this past February. When the company released its first-quarter earnings results, he said, “This is a pivotal year for Intel. We are setting our strategic foundation and investing to accelerate our trajectory and capitalize on the explosive growth in semiconductors that power our increasingly digital world.”
Intel has struggled to report encouraging results in recent years given the decline of its flash-memory business and its loss of chip manufacturing leadership. However, given its focus on taking advantage of the growth in the semiconductor industry to claim more market share, which it could then leverage to accelerate the development of new technologies, it seems the company’s stock is being underestimated by the market at its current price.
Intel’s struggles
Intel is widely considered the U.S.’s last hope of regaining a leadership position in the advanced semiconductor manufacturing industry. Over the decades, an increasing amount of chip production has been outsourced to lower-income countries in order to take advantage of cheaper labor, and while this has been nice for helping the companies buying the chips to report higher profits, it hasn’t exactly worked well in terms of the ability of U.S. companies to maintain semiconductor manufacturing leadership.
Given the higher chip production volume of foreign competitors and the greater amount of research money flowing towards said competitors, it was really only a matter of time before even Intel began to see the end of its glory days. Quarter after quarter in recent years, Intel has seen revenue for its NSG and PSG operating segments decline. The sales of the Client Computing segment have been better and have still mostly reported growth, but an increasing number of desktops and laptops sold have used less expensive chips, and Apple (AAPL, Financial) has also begun using its own chips instead of Intel’s.
Moreover, Intel has been struggling to meet deadlines and complete projects that it has invested in. For example, last year, the company delayed its 7nm process node, which was already at least 12 months behind the company’s internal roadmap. The company eventually ended up pushing back the release date of its 7nm chips to late 2022 or early 2023. Many of the company’s endeavors in artificial intelligence and 5G have also either failed or have yet to pay off.
Pressure has mounted from investors calling for the company to outsource more of its chip production in order to provide a quick boost to the bottom line. A manufacturing turnaround is going to be expensive, and some believe that an endeavor to play catch-up with international giants such as Taiwan Semiconductor Manufacturing (TSM, Financial) would be pointless anyway.
The problem with this strategy would be that it would essentially doom Intel to become a company in permanent decline, existing only to squeeze out a few last boosts for investors before beginning a slow but steady downward journey.
Scaling up operations
While many U.S. companies still design their own chips, the production of said chips is mostly outsourced. Intel is one of the few companies that still supply themselves with advanced manufacturing. It even has some factories in the U.S., specifically Oregon, Arizona and New Mexico.
Scaling down fabrication capacity has two main drawbacks. For one, fabs benefit greatly from scale because greater scale leads to greater efficiency. Semiconductors are made on silicon wafers carrying hundreds of individual chips, and advanced processes can involve upwards of 700 steps and 80 imaging levels. Each step is challenging and carries a risk of error, so it is critical to have a high success rate for each stage. If 99.99% of the chips that pass through each stage are free of defects, by the time they make it through 700 steps, only half of the individual chips will be successful products. A 99% yield for each step would result in a 0% yield overall. Manufacturers learn by doing, and the higher the cumulative output, the higher the yield percentage typically is as workers in every stage are less likely to produce chips with errors.
Another disadvantage to scaling down fabrication relates to the U.S. as a whole. The current global semiconductor shortage serves as a reminder that in the case of shortages, those with a local supply chain have the advantage over those who rely on faraway manufacturers for essential components.
Fortunately for Intel, the semiconductor shortage and expected industry growth makes the task of scaling up its operations less daunting. In 2020 alone, global semiconductor sales increased 6.5% to $439 billion, according to the Semiconductor Industry Association. For the 2021 to 2026 period, the Semiconductor Industry Landscape report expects the market for semiconductors to see a compound annual growth rate of 6%, driven by consumer electronics, AI, internet of things and advanced customized chips.
“We believe the market, the world, is in a very expansionary period,” Gelsinger said. “I predict there’s 10 good years in front of us, because the world is becoming more digital, and everything digital needs semiconductors.”
Intel plans to spend $20 billion to build a chip fabrication plant in Arizona. It also recently announced that it plans to become a “foundry,” which is a company that manufactures microchips for other companies. According to Gelsinger, the company plans to announce an additional “mega fab” in the U.S. or Europe before the end of 2021.
Valuation
While there is no guarantee that Intel will be able to live up to Gelsinger’s assertions that the company can catch up with and even surpass the incumbent chip foundry leader, Taiwan Semiconductor, the company certainly plans to make an effort and is willing to invest the necessary funds. The company may have been surpassed by competitors, but that doesn’t mean it can’t grab the top spot again someday. Even if it does not manage to become number one, it can still benefit strongly from the growth of the semiconductor industry, especially since the U.S. government would almost certainly favor a homegrown option for government contracts.
As of June 17, shares of Intel traded around $57.18 for a market cap of $231.20 billion and a price-earnings ratio of 12.87, which is far below the industry median price-earnings ratio of 28.94 but in line with the company’s own 10-year median of 12.73. The GuruFocus Value chart rates the stock as fairly valued.
The company has a financial strength rating of 6 out of 10 and a profitability rating of 9 out of 10. The Altman Z-Score of 3.66 and Piotroski F-Score of 6 out of 9 show a fortress-like balance sheet. The return on invested capital is typically higher than the weighted average cost of capital, indicating the company is creating value for shareholders.
According to GuruFocus’ free cash flow-based discounted cash flow model, the stock’s intrinsic value should be somewhere around $92.78.
Many gurus also seem to think Intel has been a good buy recently, as more gurus have been buying the stock than selling it over the past three quarters.
Conclusion
Intel’s stock seems undervalued by several metrics, which is understandable given the company’s struggles over the past few years and the expectation of many investors that it would be better for the company to just outsource production rather than struggle to hold on to its own semiconductor fabrication capacity.
However, given the decade of expected growth for the semiconductor industry, with demand predicted to achieve a compounded annual growth rate of 6% or more through 2025, someone needs to rise to meet that demand. As the once-leader in advanced semiconductor manufacturing, Intel has a strong edge in this endeavor. While its goal is to grab the number one spot, even if it does not manage this, it should at least be able to report strong earnings growth for years to come.
