Intel: A Top 40 Dividend-Growth Stock - Seeking Alpha

There has been a lot of interest lately in Intel (INTC) as a dividend or dividend-growth stock, especially after they announced that they will increase their dividend 16% in Q3 2011. That follows a similar increase at the end of last year. With the two increases, Intel’s current (projected) yield has jumped above 3.5%.

Intel just fell short of making my Top 40 Dividend-Growth Stockscompilation earlier this year, being one of the last stocks eliminated when I finalized the list in January. I always encourage investors to keep checking out new ideas throughout the year, so I decided to re-rate Intel to see whether it would make the list now. The answer is Yes.

Summary

Intel is a tech stock, and it is still hard for many people (including me) to get their heads around the idea that a tech stock can be a dividend stalwart. The new paradigm does not require the breakneck growth usually associated with tech stocks but rather sustainable cash-generation capabilities and corporate policies to pay dividends rather than hoard all the cash.

Intel seems to have navigated the difficult transition from corporate adolescence to adulthood. Corporate maturity has brought Intel around to the activities of other consenting adults, such as dividends and share buybacks. Intel no longer retains all of its earnings to fuel turbocharged growth. It doesn’t have to. It has plenty of cash and a solid financial structure to finance all the growth it can muster, yet still pay out some of its earnings as dividends at the same time.

While its first dividend was paid all the way back in 1992, Intel has been raising dividends now for 8 consecutive years and doing it at such a pace that its current (projected) yield is 3.7%. With a balance sheet that resembles a fortress, no debt, monopoly characteristics in its core areas, robust R&D to keep it at the head of the pack, and an apparent commitment to keep raising its dividend, Intel now clearly qualifies as a Top 40 Dividend-Growth stock. Let’s call it Number 41 for 2011.

Type of Company and Stock

In Morningstar’s Style Box, INTC is classified as a large-cap core stock. Morningstar uses “core” to indicate that a stock shows both value and growth characteristics. INTC has a market cap of about $121 billion.

Intel’s cyclicality shows up in volatile earnings and also in its stock price. In the 10-year chart, notice all the peaks, valleys, and sudden trend reversals. E-Trade lists its beta as 1.1, a little more volatile than the market as a whole. A high beta is not a quality usually associated with a dividend-growth stalwart. A little later, we will contrast this price volatility with the past few years’ performance in the company’s dividends. The difference is striking as well as being a key to whether Intel can be considered a dividend stalwart.

The chart also makes Intel look like a stock that has “gone nowhere” in the past 10 years. The 10-year price trend is down, and that is a familiar look to dividend-growth investors who understand that many of the best dividend stocks were way overvalued 10 years ago. The long-term decline in price is in fact one reason that such stocks even have a chance today to be considered cornerstones of a dividend-growth strategy. Without the price declines, their yields would be too low to be of interest. Without Intel’s price decline, even at today’s payout rate, its yield would be about 2.4% rather than the 3.7% that it actually is.

Intel’s website is accessible here. Except where otherwise noted, all figures in this article are from Morningstar, the company’s website, David Fish’s Dividend Champions document, Robert Alan Schwartz’s dividend growth company site for Intel, and my own calculations.

Intel’s Story

The story for a stock examines the company’s business model and sustainable competitive advantages. It answers the question, “How does this company make money?” It’s an important component in my scoring system. If you can’t understand how a company makes money, or it doesn’t make sense to you personally, don’t invest in it.

Intel has a great story. It is the world's largest semiconductor chip maker. Intel designs and manufactures computing and communications components (microprocessors, chipsets, motherboards, and connectivity products), as well as platforms that incorporate these components. The company also develops advanced digital integrated circuits (semiconductor chips etched with electronic switches) and suites of digital computing components. Intel offers products at various levels of integration, but most of its revenue comes from the sale of microprocessors and chipsets.

Intel is about 9 times the size of its chief rival Advanced Micro Devices (AMD). It has dominated the $30 B computer processor market for many years. Its market share ranges up to 80% by some estimates. AMD briefly narrowed the gap a few years ago, but Intel accelerated away and reasserted its near monopoly in the microprocessor market.

Intel enjoys significant competitive advantages in its massive R&D capability as well as the financial resources to employ cutting-edge manufacturing technologies. Intel keeps raising processor performance while lowering manufacturing costs. The company has laid out aggressive plans to introduce new chip architectures every two years, still following Moore’s Law (faster and faster processing at lower and lower cost) after all these years. Intel recently launched its line of Sandy Bridge chips, which combine computer and graphics processors onto the same device, and it will begin later this year to ramp up the manufacture of state-of-the-art 22-nanometer (circuit size) chips.

Intel faces several challenges, although a couple of them come with silver linings.

• The PC market is maturing in the developed world, so Intel has a monopoly-like share of a flattening market. However, the silver lining is that the PC market is nowhere near saturation level in less-developed countries. This is a source of continuing growth for Intel that is sometimes overlooked.
• Smartphones, tablets, and other mobile devices comprise the exploding market in computing, and Intel is a weak player in this market. Disruptive competitor ARM Holdings (ARMH) designs processors for smartphones and tablets, and they are better at it than Intel. While the dividing line between PCs and mobile devices is blurring, ARM has been much more successful in processors for mobile devices, because of its advantage in lower power consumption. Mobile devices don’t need Hummer-like strength as much as they need great mileage, which in computing means longer battery life. Intel has recognized the market’s needs, and it is turning significant attention to becoming more competitive with its Atom line of chips. But as of now, Intel has had only limited success in getting its Atom chips designed into tablets and smartphones. Intel bolstered its capabilities in this area by acquiring Infineon's wireless chip business earlier this year.
• No matter how well it does in that race, the attachment of more and more devices to the Internet is another silver lining for Intel. “Cloud computing” requires massive server build-outs. Intel’s server processor segment is its most lucrative. Its recent acquisition of antivirus and security software maker McAfee was strategic to this area, as Intel believes that security is becoming increasingly important with the proliferation of connected devices. The company can integrate security features directly into its chips and hardware. The rapid proliferation of mobile devices will require substantial build-outs of Internet infrastructure, which in turn should drive demand for server processors. The company expects its data center business to be a source of growth for years to come.

I give Intel about three-fourths of full credit for its story. This is a high score, one that few companies attain, as I try to be a hard marker when it comes to the company’s story.

Financials

Intel has a fortress balance sheet. Its debt/equity ratio is essentially zero. The company is a cash-generating machine, but the machine operates unevenly, because of the cyclical nature of the business. (Cash numbers are in millions.)

	2010	2009	2008	2007	2006	2005	2004	2003	2002	2001
Free Cash Flow	11,485	6,655	5,729	7,625	4,841	9,005	9,276	7,859	4,426	1,345
Cash at End of Year	5,498	3,987	3,350	7,307	6,598	7,324	8,407	7,971	7,404	7,970
EPS	2.06	0.79	0.93	1.20	0.87	1.42	1.17	0.86	0.47	0.19
EPS Growth	160%	-15%	-22%	38%	-39%	21%	36%	82%	147%

Intel’s current ROE is 27%, but it has been above 15% for only two years in a row, again the result of cyclicality. (Its ROE is not juiced by high debt.) Analysts’ estimates for future EPS growth are 11% per year for the next 3-5 years.

Intel’s fiscal year ends in December. It reported spectacular first-quarter results this year. Revenue was up 12% sequentially and 25% year over year, fueled by spending on computers from enterprises and emerging markets. Average selling prices were boosted by the latest Sandy Bridge chips. Gross margin was 61%.

In a recent press release, the company said, "Worldwide demand for computing continues to increase at a very rapid rate, putting Intel on track for revenue growth of over 20 percent this year, delivering another record year for the company. Intel's current and projected growth is generating strong cash flow, allowing us to further increase our dividend.”

The Dividend Picture

2011 will be the eighth consecutive year that Intel has raised its dividend. Their dividend history divides into two eras. Starting from a negligible dividend in 1992, they embarked on a low-yield Dividend Challenger path, raising their dividend each year through 1999, but then they hit a wall in 2001.

1993	1994	1995	1996	1997	1998	1999	2000	2001	2002	2003
$0.01	$0.01	$0.02	$0.02	$0.03	$0.03	$0.06	$0.07	$0.08	$0.08	$0.08

Because I have rounded the figures, it appears that some dividends up to 2000 stayed flat although they were actually increased fractionally every year. But the dividend was held flat at $0.0800 from 2001-2003.

Then the second era began.

2004	2005	2006	2007	2008	2009	2010	2011 e
$0.16	$0.32	$0.40	$0.45	$0.5475	$0.56	$0.63	$0.78
+100%	+100%	+25%	+13%	+22%	+2%	+13%	+24%

The new era is different in amount, percentage increases, and apparent intent. In announcing its latest dividend increase, the company stated, “Intel's dividend payout has steadily increased at a 33 percent compound annual growth rate (CAGR) since 2003, compared to the Standard & Poor ((S&P)) 500 growth rate of 6 percent over the same period.” And “We are delivering on our commitment to return cash to shareholders with annual dividend growth that's already more than five times the S&P 500."

My interpretation of all this is that Intel now has a real dividend-growth culture, as opposed to the earlier era when it was just sort of messing around with a dividend. It is significant that in 2009, when many companies cut their dividends and Intel itself had suffered EPS declines in three of the preceding four years, the company still managed to increase its dividend, even if just a little bit. That speaks volumes about its new-era dividend policy. So does the fact that it is bragging about its dividend performance in press releases.

Intel also has a share buyback program in place. Intel increased the authorization limit for share repurchases by an additional $10 billion in January to a total of $14.2 billion. I have not studied this program and it plays no role in my evaluation of the company. I do not begrudge the money going to the repurchase program given Intel’s strong recent record of dividend increases.

Valuation

I use several valuation ratios to value stocks, comparing a particular stock’s ratios to market-wide historical benchmarks, as well as the stock’s own P/E ratio to itself historically. By my way of reckoning, Intel has a “Good” valuation right now, meaning that it is undervalued. Its P/E of 11 is much less than its five-year average of 20. It has a PEG ratio of just 0.8, and a P/CF of 8. Intel’s earnings yield (the inverse of P/E) is 9.6% compared to the S&P’s 6.6%.

In looking up the valuation ratios for this article, I noticed that Morningstar has introduced a new data point, Price/Fair Value. That comes in at 1.0, meaning that Morningstar thinks that Intel is just fairly valued at the moment. Its 3-star rating on the stock would suggest the same thing. Morningstar computes “fair value” using a proprietary NPV approach, so they use a different method from mine and reached a different conclusion.

Consensus analysts’ ratings clock in at 1.5 on the familiar 1 (Strong Buy) to 5 (Sell) scale. Intel’s 1.5 equates to about “Buy+.” I normally discount analyst ratings due to historical “sell side” optimism, but nevertheless I give them some credit for directional correctness.

Investment Thesis and Conclusion

Intel is worth a long look as a dividend-growth stock and potential Dividend Champion of the future. The biggest concern is with the cyclical nature of its business and earnings, and the impact the cyclicality could have on consistent dividend increases in the future. But Intel seems to be fairly or even advantageously valued right now, and its 3.7% yield is a strong starting point for a long and prosperous relationship. I don’t believe that Intel will clock many more dividend increases of 20%+, but it does not seem out of the question that the company could average increases in the 10-12% range for several years. At 10% per year, the payout and yield on cost would both double in a little over 7 years.

I conclude that Intel is indeed a Top 40 Dividend-Growth Stock. A few weeks ago, I terminated a Capital Gains Portfolio and moved that money over to a personal Perpetual Dividends Portfolio. On Tuesday, I backed up the truck and used about 20% of that “new” money to purchase Intel. It’s funny: In the late 1990’s, I owned Intel for its growth and made a few bucks. This time, it’s a new era, and I bought it for its dividend. I hope to hold it for a long time and watch its dividend grow every year.

For those who are looking for at least a 4% initial yield, the purchase price required would be $21.00 at the newly announced payout rate of $0.84/year. I saw no reason to wait and got mine at $22.44.

Disclosure: I am long INTC.