Can Internet Of Things Be The Next Growth Driver For The Intel Stock?

  • Intel sees tremendous potential in its Internet of Things business.
  • Intel stock is quite attractive right now due to its compelling valuation.
  • The average target price of the top analysts is at $37.63, an upside of 9.9% from its August 3 close price.

As PCs sales have continued to decline and because Intel (NSDQ:INTC) has missed the mobile revolution, it has been looking for new key growth drivers. As such, on April 19, the company announced a restructuring initiative to accelerate its evolution from a PC company to one that powers the cloud and billions of smart, connected computing devices. Since Intel believes that the Internet of Things (IoT) market will be the next big wave in computing, in 2014 it changed its reporting structure and made Internet of Things a stand-alone segment. In the second quarter conference call, CEO Brian Krzanich said:

"The Internet of Things business was up 2% over last year, coming in below our expectations. We saw growth in the industrial and video verticals offset by an inventory burn after a very strong first quarter. We continue to see tremendous potential in this business."

According to Business Insider report, almost $6 trillion will be spent on Internet of Things solutions over the next five years. The research company, IoT Analytics, ranks Internet of Things companies. According to its latest web-analytics ranking, there is a head-to-head race going on between five companies: Intel, Microsoft (NSDQ:MSFT), Cisco (NSDQ:CSCO), Alphabet Inc-A (NSDQ:GOOGL), and IBM (NYSE:IBM).

However, Internet of Things accounted for only 4.2% of Intel's revenue in the second quarter of 2016, and 4.7% of the revenue in the first quarter. What's more, the IoT operating income of $89 million in the second quarter and $123 million in the first quarter accounted for only 2.8%  and 3.7% respectively of the company's operating income in the second and the first quarters of 2016.

 The average Internet of Things revenue growth in the last six quarters was 9%, as shown in the charts below.

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Although the Internet of Things contribution to Intel's success will be more significant in the next few years, INTC stock is a smart investment right now due to other reasons.

Second Quarter Results

On July 20, Intel reported its second-quarter 2016 financial results, which beat earnings-per-share expectations by a significant margin of $0.06 (11.3%). Revenues for the quarter grew 3% year-over-year to $13.53 billion but were slightly below Wall Street's estimates of $13.54 billion. The company beat earnings-per-share estimates in all its last five quarters, as shown in the table below.

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Source: Yahoo Finance

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Source: Intel report

In the report, CEO Brian Krzanich said:

"Second-quarter revenue matched our outlook and profitability was better than we expected. In addition, our restructuring initiative to accelerate Intel's transformation is solidly on-track. We're gaining momentum heading into the second half. While we remain cautious on the PC market, we're forecasting growth in 2016 built on strength in data center, the Internet of Things and programmable solutions."

Client Computing Group (PC) the largest segment, which accounted for 54.2% of total net revenue in the last quarter, saw its revenue decline 2.6% year-over-year to $7,338 billion. However, its operating income grew 19.2% to $1,911 billion. Data Center Group the second largest segment, which accounted for 29.8% of total net revenue in the second quarter, saw its revenue rising 4.5% year-over-year to $4,027 billion. However, its operating income dropped 4.2% to $1,765 billion.

Business Outlook

In its second quarter report, Intel offered an outlook for the third quarter and the full year 2016. For the third quarter, Intel expects revenue of $14.9 billion, an increase of 10.4% from the second quarter and well above market expectations. Usually, the third quarter is seasonally high since electronic products manufacturers are buying more chips for the holiday season. However, according to Intel, the expected growth is high even after seasonal adjustment.

Valuation

INTC's stock has underperformed the market in the last few years. Year to date, INTC's stock is down 0.6% while the S&P 500 index has increased 5.9%, and the NASDAQ Composite Index has gained 3.0%. Moreover, since the beginning of 2012, INTC's stock has gained only 41.2%. In this period, the S&P 500 Index has increased 72.1%, and the NASDAQ Composite Index has risen 98.1%. According to TipRanks, the average target price of the top analysts is at $37.63, an upside of 9.9% from its August 3, close price, however, in my opinion, shares could go higher than that.

INTC Daily Chart

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Chart: TradeStation Group, Inc.

Intel's valuation is excellent, the trailing P/E is at 16.53, and the forward P/E is very low at 12.55. Furthermore, its price to cash flow ratio is at 9.03, the Enterprise Value/EBITDA ratio is very low at 7.68, and the PEG ratio is at 1.42.

In addition, Intel's Margins and Return on Capital parameters have been much better than its industry median, its sector median and the S&P 500 median as shown in the tables below.

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Source: Portfolio123

In its latest quarter, the company generated approximately $3.8 billion in cash from operations, repurchased $804 million in stock, and paid $1.2 billion in dividends. Intel has been paying uninterrupted dividends since 1993. The forward annual dividend yield is pretty high at 3.04% and the payout ratio is only 35.2%. The annual rate of dividend growth over the past three years was at 3.3%, over the past five years was at 8.8%, and over the last ten years was high at 11.6%.

Conclusion

Although Intel sees tremendous potential in the Internet of Things business, it will take few more quarters until it will represent a significant contribution to the company growth. However, Intel's stock is quite attractive right now due to its compelling valuation. Moreover, the company generates strong cash flow and returns substantial capital to its shareholders by stock buybacks and increasing dividend payments. The average target price of the top analysts is at $37.63, an upside of 9.9% from its August 3, close price, however, in my opinion, shares could go higher than that.

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