Intel Corp. Buy Reiterated; $180 Price Target Reaffirmed
Lehman Brothers - Research Highlights 3/19/99
*We believe that the worst of the near-term correction in Intel's stock price is over.
*We reiterate our 1 Buy recommendation and reaffirm our 12-month price target of $180.
*The recent confusion in the PC market probably reflects a slightly greater than normal seasonal effect but no significant structural slowing.
*We believe that Intel's longer-term earnings can grow at the high end of a 25-30% range.
*Intel's common is currently selling at a discount to the market which we believe is excessive under valuation.
Barring a major setback in the stock market, we believe that the worst of the predicted near-term correction in Intel's stock price is over. We reiterate our 1 Buy rating on its common and reaffirm our 12-month price target of $180 per share. One caveat remains. We expect Intel to report a sequential decline in revenues and earnings in the first quarter as do most observers. However, we continue to have one of the lower first quarter estimates, as has been the case all quarter. This does not reflect a structural deficiency or a particularly pessimistic outlook for PC demand. Rather, it reflects our view that seasonal pressures will be somewhat greater in the first quarter than is typical for three principal reasons: First, the fourth quarter was unusually strong. Second, we believe that some first quarter PC purchases were deferred awaiting the introduction of the Pentium III. Third, the PC market has typically experienced a more pronounced seasonal weakness in the first quarter than have their semiconductor suppliers because of shipment timing differences. Because of increasing use of build-to-order models by Intel's PC customers, we expect these seasonal patterns have become more closely aligned. We expect sequentially higher revenues and earnings to be reported during the remainder of the year.
Three principal factors have contributed to the correction of Intel's share price during the first quarter. First, the rapid rate of appreciation of Intel's stock left it extended and requiring consolidation. Second, cross currents in the PC market suggested that demand for Intel's microprocessors might be weaker than expected. Third, rumors developed that the company would be preannouncing a disappointing quarter.
Intel's shares and semiconductor stocks in general appreciated by 68% and 72%, respectively, during the fourth quarter of 1998. This left the company's and industry's stocks in a temporarily extended position which was one of the reasons that we predicted a 10% to 15% correction for the group during the first quarter. As it turned out, the group corrected 14% from its peak to its trough but has subsequently recovered to where it is now down only 8% from its peak. Intel performed worse than the group and worse than we had expected by declining 22% from its peak to its trough ($141 per share to $110 per share). It has now recovered to a price of $122 leaving it 13% below its high.
We believe that the passing of time and the stock price contraction has increasingly dissipated the corrective pressure on the company's (and industry's) shares that had developed because of the fourth quarter appreciation rate. Near term, investors may continue to exercise some caution because of the upcoming reporting period. However, with that behind it, the semiconductor industry enters a period of seasonal strength. At the same time investors could be looking toward three quarters of sequential growth for Intel. We believe that these conditions could end the consolidation phase of both the semiconductor industry and Intel's shares and appreciation of both could resume following the first quarter reporting period.
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The investment case we have been making for Intel's common remains unchanged. On a longer-term basis we expect Intel's mircoprocessor unit shipments to generally grow within a 15%-20% range, including those devices that go into the workstation and server markets. These currently contribute about an estimated 5% of total microprocessor units but about 25% of microprocessor dollars because of an average selling price that we believe exceeds $1,000 per unit. This market is growing at a 30% rate, about twice as fast as PC demand, which we believe will largely offset the price pressure that exists in the low performance end of the microprocessor market. Consequently, while total average selling prices may erode slightly, we believe that Intel's revenure growth can still hold within a 15%-20% range during the next two years. Beyond that time with the introduction of Merced, the company's 64-bit high performance microprocessor to be sampled late this year, revenue growth could accelerate. The target market for Merced is high-performance commercial servers. As such, this will be an additive market with system shipments to begin in 2000. This could enable total company revenue growth to accelerate to the 20%-25% range beginning in the 2001 time frame.
Gross margins could expand by about four percentage points during the next two years as packaging costs are reduced and other cost containment procedures are continued. Expense ratios are also expected to decline. These elements, together with an ongoing share buy-back program and an expanding revenue growth rate in the out years, could enable intel's earnings per share to grow at an average rate at the high end of a 25%-30% range during the next five years.
The normalized price-earnings/growth rate ratio for the semiconductor industry is presently about 1.2. We believe that within this framework, the company deserves a premium valuation relative to the group. A ratio of 1.4 suggests a price earnings ratio of about 40 times trailing earnings which in turn indicates a 12-month price target of $180 per share. A multiple of 40 times trailing earnings would indicate a value relative to the S&P 500 of 1.4, or a 40% premium to the market. This does not seem execessive if Intel can, indeed, expand it's earnings at a rate that is about 4 times that of the market. Currently, the common is selling at 26.0 times our 1999 estimate which is a discount to the value of 27.7 times earnings being accorded the S&P 500. Stated another way, Intel's common is selling at a relative multiple of 0.94 which in our view places the stock at a level of significant under valuation. As a result, we reiterate our 1 Buy rating and recommend that the stock be purchased in aggressive accounts. |
