Investment Analysis

Section 3

Austin Trent- Company and Industry Teancum Light- Company and Industry

Spencer Barlow- Economy

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Conclusion The following report examines the corporate

strategy and position of Intel Corporation. After

careful study and analysis of the information we

researched, we have compiled the following

report, which discusses the different aspects of

Intel, as well as the competitive nature of the

industry and economic environment. We have

given a buy rating to Intel. There are both risks

and advantages to investing in the tech industry,

which will be discussed more thoroughly

throughout the paper. A comprehensive analysis

of the company, industry, and economic

environment will further support our proposal.

Ultimately, we support a recommendation to buy

Intel stock at its current price of $21.86. We have

established a target price of $25 for year-end

2010. Our analysis relies on assumptions and

calculations that are described throughout the

report and are supported by accompanying

exhibits.

Company Description Intel Corporation makes microprocessors,

chipsets, flash memory, wireless cards, and

networked storage products for desktop PCs,

notebook computers, servers, workstations, and

other consumer products. The company sells to

OEMS and distributors worldwide. The company

was founded in 1968 and employs over 80,000

people. Intel’s headquarters are located in Santa

Clara, CA.

Products The recent release of the i7-based computer

boards has been a huge success. The Intel i7-based

boards have been designed to accommodate

military, industrial, and telecom applications.

Advantech Co. Ltd. is in Irvine, California and has

created the Intel Core i7 processor, ranging from

computer-on-modules and single-board computers

to industrial motherboards for tasking and digital

media solutions in military, factory automation,

telecommunication, medical, and casino gaming

applications. Advantech is also releasing four

more industrial motherboard embedded computer

products based on Intel’s Core i7 processor; the

Mini-ITX motherboard AIMB-280, MicorATX

motherboard AIMB-580, ATX motherboard

AIMB-780, and the PICMG 1.3 SBC PCE-5125.

We expect these releases to dominate the high end

market for the next year. By providing embedded

software support for these boards consisting of

Windows 7, XPe, and Linux, Advantech will

continue to maintain a loyal customer base for

Intel.

Another big success for Intel has been the

microprocessor market. Intel was responsible for

80.8% of the microprocessors shipped in 2008.

The only significant competitor, AMD, only has

17.8% of the microprocessor market share.

Microprocessor Market Share 2008

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AMD could take some market share this year, but

we do not expect AMD’s Magny-Cours to

threaten Intel’s performance crown. AMD will,

however, have an opportunity to pick up market

share in the lower-ASP and mainstream markets.

They should be able to do this with a great price

schedule as well as excellent system power

consumption.

Structure Although Intel’s competitors face volatility due to

their cyclical nature of sales, Intel is able to absorb

revenue fluctuations because of its large size and

corporate structure. We will now analyze the

strategic position of Intel by observing

differentfinancial ratios, including: profitability,

leverage, efficiency, liquidity, the DuPont

framework, PE ratio, and others relevant to Intel’s

corporate structure.

DuPont Framework With an analysis of the DuPont Framework we

can pinpoint why Intel’s ROE dropped from

23.29% in 2005 to 10.48%. All three of the

components of the DuPont Framework dropped;

however, the drop in profitability made the largest

impact on ROE. Profitability dropped from

23.29% in 2005 to 10.48% in 2009. This

reduction in profitability was due to increased

non-recurring expenses, not a decrease in sales. If

profitability had remained constant from 2005 to

2009 ROE would have been 18.8%.

Liquidity

Intel’s conservative capital structure has provided

the company the liquidity and flexibility it needs

to be the leader in its competitive industry. Intel is

more liquid than the industry average, and only a

fraction of its long term debt will mature within 5

years. As of September 2009 Intel had total LT

debt of 2.2 B while only 176 M or 8% is due in 5

years.

Efficiency Intel’s efficiency as described by turnover ratios and collection period is better than the industry

average. There is no significant difference between Intel and the competitor average when it comes to

inventory turnover, asset turnover, days to sell inventory, and operating cycle. However, Intel exceeds

competition in average collection period and receivables turnover. Intel’s average collection period in 2009

was 58% (29 days) less than then industry average. Intel’s receivables turnover in 2009 was 2.15 times

larger than the industry average. Intel is more efficient than the industry because it is able to collect cash

faster.

Intel

AMD

Other

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Profitability When the Duo Core Intel Processors entered the market prior to 2004, Intel dominated market share. With

few competitors, Intel was able to make sales at a premium. Over time, multi-processor competition entered

the market forcing Intel to decrease its price in order to remain competitive. AMD announced its duo core

processors in 2005, marking the beginning stages of a price war. Intel has been a worthy competitor.

Looking at profitability, Intel is leading the industry. Operating margin after depreciation is almost 8 times

greater than the industry average. Because of Intel’s size, they are able to invest in very large projects

requiring huge capital expenditures. They also invest heavily into research and development. Looking at the

tax codes, this works to Intel’s advantage. Intel can take the majority of its R&D costs and capitalize them as

long as they meet certain requirements called for by the FASB. This tax incentive allows Intel to create a tax

shield of future earnings, as amortization is deducted over future years and future earnings. In a sense, Intel

is in a position to make a lot of money with a relatively small tax expense.

Another point to consider is the recent increase in operating margin. There was a drop from 2005-2006,

which we generally attributed to AMD’s release of the duo core processor. Part of this is also due to the

market penetration of other companies as well. The industry is highly competitive, creating a difficulty for

Intel and other tech companies. Intel’s greatest assets lie within its management, engineers, and

programmers, whose talents are responsible for Intel’s financial success. However, some of these employees

start their own development companies that end up competing with Intel. With over 43,000 valuable

employees, there is a reason Intel is ranked in the in Fortune 500’s top 100 companies to work for. They

cannot afford to lose their greatest assets.

One might also wonder why the industry average is depreciating so much. The difference between Intel’s

operating margin before and after depreciation is about 14% while the industry average difference is about

18%. Reason for this difference will be discussed later when analyzing competing companies.

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EPS We expect Intel’s EPS to increase to 1.47 by the end of 2010 because of the recovering market and

increasing demand. Intel’s customers have begun to increase inventories. S&P analysts believe that sales

will rise 19% due to these replenishing inventories of big customers.

P/E Ratio and Stock Price estimate Intel’s 10 year P/E rage is 13-80. Like we saw in 2005, as earnings increase Intel’s P/E will

decrease. Analysts have been using a P/E ratio of around 15 to predict 2010 stock prices. We estimate

Intel’s stock price at the end of 2010 to be 24.9 (1.47eps X 16.93p/e).

Cash Flow Intel generates large amounts of cash through operating activities. The question is not whether Intel

has enough cash for continued operations, but whether its stockholder return is maximized by Intel

holding massive cash reserves. In 2009 Intel reported $3.98B in cash and cash equivalents. In

Intel’s defense, it has continued paying dividends through the recession while many other companies

have stopped. Also, excess cash gives them the flexibility they need to continue to be the industry

leader. On one hand, excess cash may not give investors maximum return, but on the other, it does

make Intel a less-risky investment.

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Strengths Intel is definitely leading the industry. They have

established a profitable history giving them more

access to cash than other companies. Currently, Intel

has a very large reserve of cash compared to any

competitors. They are waiting to make sure they do

not assume too much risk in a foolish investment.

Perhaps Intel’s greatest strength is their accounts

receivable turnover of 17.3 compared to the closest

comparable of 10. At a time when cash is tight, Intel

is able to collect almost 15 days earlier than any

other company in the industry. They have

established a system that creates incentives for

corporations and retailers to pay quickly. Other

companies are especially struggling because of the

economy. They don’t have cash flowing in as

quickly as Intel and are not in a position to exploit

very profitable opportunities. Another area where

Intel is excelling is its amazing profit margin even

during a tough year. Intel’s operating margin before

depreciation was almost 39% compared to the next

highest margin of less than 30%. The profit margin

after depreciation is still 25% compared to 21%. By

referring to the exhibits following this section, you

can see that the majority of the companies recorded

negative profit margins after deducting depreciation.

Generally, depreciation works as a tax shield, but

very few were able to benefit because of economic

conditions. They can afford to leverage more

because of their name. Intel also has a huge

advantage when it comes to economies of scale.

Unprofitable projects can be absorbed, unlike in

smaller companies. This also allows Intel to engage

in riskier projects that could potentially outperform

competitors. While the economy was hurting all

around, Intel decided to take a harder hit than

needed. An account called accrued expenses was

huge on Intel’s balance sheet. This has set Intel up in

such a way that target earnings will be easier to

meet. And most importantly, Intel is a name people

know, trust, and show loyalty to. Because of this

loyalty, Intel has a huge market share that is difficult

for competitors to steal.

Weaknesses The problems Intel now faces are a reflection of the

new world it finds itself in. It appears to be faced

with three conflicting issues: the commoditization of

the PC industry, the steady decline of selling prices,

and the rise of AMD, which, from the moment it

beat Intel to the lGhz processor, found a new

confidence. Intel was always the safe choice for the

consumer. Whatever else was on the computer box,

you could trust the Intel Inside sticker. Today the

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consumer no longer appears to need that

reassurance. They are now looking for the best price.

In the past, size has created a huge advantage for

Intel, but now that comes with some costs. Intel is in

such a hurry to stay ahead of the industry that some

of their own products become obsolete due to

upgraded products released by Intel. Normally we

would look at the current ratio, but we believe this

ratio is unrevealing because of the inventory on hand

from the drop in sales during the recession. Intel

shows a low current ratio, which fortunately is not

made up primarily of inventory like competitors.

Inventory is also an area of concern. Among the

comparables, Intel has the lowest inventory turnover

for the last year. Although typically a red flag, we

have to realize the state of the economy. With

forecasted sales growth, we predict Intel’s inventory

turnover will regain its leading position. They are

also spread thin while trying to maintain market

share. There are too many products becoming

available. Intel is also susceptible to a lot of legal

costs. Some of these costs may be included into an

account that was quietly slipped into the balance

sheet. As we filtered through this data, we liked a lot

of what we saw, but there was one thing that stood

out like a sore thumb. On the balance sheet, Intel had

included a liability called accrued expenses.

Typically, the liability is current and due within the

year. While we mentioned above that this could

benefit Intel, it may also put them in a tight cash

flow situation later in the future when expenses are

actually paid. A lot of legal authorities see Intel as

dominant and capable of absorbing legal costs.

Smaller companies generally win many of their

cases against Intel.

Opportunities If you understand the tech industry and can keep up

with the pace of innovation, there will always be a

growing market. There are also many opportunities

to create supply chains that maximize profits for

everyone. If a company can become the best at a

particular task, multiple companies should use them.

By specializing in a particular area, companies

create greater capacity and productivity. However,

there are risks of losing out on potential profits. Intel

has developed internally as much as possible. They

outsource very few tasks, because they know that

there is a steep learning curve in the tech industry.

Companies that can strategically adapt to new

environments will survive. Based on the S&P

forecasts, sales in this industry should increase by

19% in 2010. Any company with cash and resources

available could find a niche and grow at an

accelerated pace. Cultures and lifestyles are

changing rapidly, and companies that can adapt to

constant changes of consumer demand will gain

remarkable market share. Technology is becoming

an essential to everyday life. Every day there seems

to be a new market emerging. Best of all for Intel,

there are few dominant competitors.

Threats Volatility is the best word to describe the tech

industry. Technology is moving so rapidly, it’s

amazing that companies are able to keep up with

consumer demand. The problem is that many fall

behind and never catch back up. The tech industry

supports innovation and not much more. Innovation

costs money, and companies do not know how the

consumer will react to the products. There is no time

to test the market before mass-producing; otherwise,

competition will steal market share. With so much

pressure to enter the market untested, companies run

the risk of releasing a malfunctioned product that

could completely eliminate loyalty and trust in the

company. There are plenty of other options

becoming available, and consumers are becoming

less and less loyal to particular brand names. As

mentioned earlier in the paper, people are some of

the tech industry’s largest assets. If employees feel

like they are being treated unfairly, they simply walk

away with critical and valuable information.

Intellectual theft can put a company out of business

in a very short time period. Another big threat is the

constant threat of disruptive technologies. All it

takes is one innovation to wipe out years of research

and development. With new discoveries come huge

expenses and obsolete inventory. The tech industry

is a harsh environment where the weak fall prey to

the better-positioned companies like Intel. Another

threat to the industry lies within the huge quantities

of research and development necessary to compete.

If a product is not successful, the tech company

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cannot capitalize those costs. Financial statements

look weak, and issuing more debt becomes

extremely problematic.

The following are excerpts from the balance sheet and other ratios supporting the analysis.

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Macroeconomic Analysis Top-down analysis of Intel’s prospects must start

with a look at the global economy. The economy

is especially indicative of the health of industry

leaders, as their performance often mirrors that of

the economy as a whole. Despite an overall

decline in the global chip market, Intel’s share of

the chip market reached 14.6 percent in 2009, up

from 13.6% in 2008. Samsung, Intel’s closest

competitor posted revenue growth in 2009.

However, its revenue was only slightly more than

half that of Intel.

A more in-depth look at Intel’s command in its

industry is further discussed in another portion of

this report. Suffice it to say that Intel’s position as

industry leader produces a tight correlation

between its performance and the Dow and

therefore, the economy as a whole.

Current leading indicators foreshadow economic

recovery and, therefore, depict Intel as a wise

investment.Evidence of an imminent economic

recovery can be found through a closer look into

current economic growth, federal policy, and

relative performance to alternative investments.

Economic Forecast Economic leading indicators reveal recovery and

growth. In the fourth quarter of 2009, the national

level of GDP rose by 5.6 percent. Although that

number is somewhat misleading (3.7 percent came

from re-stocking inventory), it still represents the

second consecutive quarter of positive GDP after

an entire year in the red.

During that same period, nonfarm business sector

labor productivity increased at a 6.9 percent. This

indicates businesses were getting more production

for their labor expenses, ultimately increasing

their ability to increase profits.

An obvious hindrance of economic growth has

been long-time unequalled levels of

unemployment of 10 percent and reduced

consumer spending. However, increases in

unemployment have recently slowed. Economists

polled in the latest Wall Street Journal survey

expect the U.S. will add an average of 132,500

jobs per month over the next 12 months. That

would keep the rate high (9%), but allow the

economy to expand its recovery.

Underutilization of capacity offers more evidence

that employment gains will occur. Ideally,

manufacturing companies utilize between 83-85

percent of their productive capacity. Currently, the

percent of capacity is 72.7 percent. This represents

a strong gain since its low of 68.4 percent last

year.

This current level of operating capacity provides

optimism for two reasons: First, its V-shaped

recovery indicates resurgence in production levels

and efficiency in manufacturing firms. Secondly,

the current level is well below the healthy

benchmark level of 83 percent. This leaves room

for economic growth without creating inflationary

pressures due to overheated capacity levels.

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Federal Policy Since the beginning of the current recession and in response to risky levels of illiquidity and inaccessibility

of credit, the Fed has lowered its target fed funds rate from about 4 percent to just above 0 percent. This has

made the cost of borrowing for banks much cheaper and increased liquidity in the financial system. The

FOMC recently announced its plan to retain this rate at 0 to ¼ percent as the economy continues to recover.

The Fed has also increased the money supply (both M1, andM2) by making large open-market purchases of

securities, filling the banks with excess reserves. While it is true that banks have built up abnormally high

levels of excess reserves, this will encourage the resumption of private credit flows to American families and

businesses as the cautious banks find credit worthy suitors.

The current yield curve gives further evidence of economic upswing. As

depicted, the yield curve rises steeply between one- and ten- and even thirty-

year maturities. The current yield spread between 30-year T-bonds and 3-

month T-Bills is 4.36 percentage points, much higher than the typical 3

points. This allows some insight to market expectations: because of the

associated risks of inflation and higher interest rates, investors are

demanding more yield as maturity extends because they are expecting

economic growth and look to be shielded from inflation by these higher

yields.

Relative Performance In conclusion to this section, performance of the firm compared to alternative investments must be

considered. According to some analysts, the firm’s stock has a forward earnings yield of 7.14 percent. This

is the return generated if profits remained constant and it paid out all of its earnings in dividends. This is par

for the industry. For the company to generate decent returns for investors, it will probably only have to

experience temperate growth in earnings or market valuation. The stocks dividend yield percentage is 193

points above the industry average. As far as macroeconomic influences, this type of moderate growth is

highly likely.

65.0

70.0

75.0

80.0

85.0

Feb-00 Feb-02 Feb-04 Feb-06 Feb-08 Feb-10

Capacity Utilization

Percent of Capacity

Ideal Operating Capacity

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Over the past 8 months, Intel has produced returns that top both the industry average and the S&P 500. Its

continued advances in technology will allow it to ride an economic recovery to sustain and even improve its

returns.

In summary, the economy seems to be in the early stages of recovery, slowing unemployment, increasing the

money supply, improving productivity, and better utilizing capacity. The growth should be slow but

sustainable. As consumers rebuild their savings and portfolios, an increase in investment will occur across

the board, increasing the value of Intel stock as an industry leader.