Income Investors: Why Intel Should Be On Your Watch List In 2012

By Salvador N. Lara

Out of the larger companies in the U.S., Intel (INTC) is fine addition to a watch for dividend-seekers and put-sellers alike. While there is much uncertainty in the global economy, Intel has the financial valuation and growth prospects that make it worth buying in the midst of any blood in the street next year.

Intel is the largest semiconductor producer in the world with $43.6 billion net revenue in 2010 and record net revenue expected for 2011 after having seen strong numbers in the last three quarters. Netbook sales boosted revenues in 2010 and 2011 but continued growth in revenues may be decelerating in the future due to Apple's (AAPL) increase in market share. Even though the netbook cycle is new and should benefit semiconductor producers for many years to come, it’s yet another choice for consumers in the personal electronics space to that might cannibalize similar products. Intel will benefit from continued improvements and innovations in the new netbook category, but the personal PC category will be sensitive to the overall economy which is still trying to regain its footing. The PC Client unit made up over 66% of the latest quarter’s revenue and is sensitive to the pocketbook of the consumer.

Intel’s profit margins are very rich and a strong positive for the company, with the most recent gross margin at 64.4%. As an investor, strong profit margins equal more cash flow for every dollar of sales. However, the semiconductor business is cyclical and competitive; margins could shrink as product cycles change. Sales could stagnate next year with a lukewarm 2012 global economy. 57% of revenue in 2010 came from the Asia Pacific region, while Europe and the U.S. made up another third of revenue. With floods in Thailand, weakness in China, and debt fears in Europe, the prospects for 2012 are anything but certain.

Intel is not an overpriced stock, with a relatively low price to earnings just above 10 with the average PE in the market at about 13. Price to sales is not excessive sitting at about 2 times sales. For companies with Intel’s size and characteristics, Intel sports an attractive price to earnings growth (PEG) at 0.97, which would have to double before becoming unattractive to most investors. But remember, the consistency and sustainability of the earnings growth is not guaranteed, especially in the competitive and innovation heavy semiconductor space. In this regard, Intel is a serious innovator given its venture capital investments in cloud computing.

It looks like Intel executives think the company is attractively priced as well. They increased the buyback of shares authorized by $10 billion dollars after purchasing $4 billion dollars worth in the 3rd quarter of 2011. They even borrowed $5 billion dollars in senior notes to complete the buyback of shares. Normally it’s not a good idea to pay interest to boost earnings per share, but Intel may just be taking advantage of favorable terms in the capital markets at the current low rates for corporates. Intel overall has low long term debt, and investors should hope they keep it this way. Given the positioning by executives, any weakness in the price of the stock should be met with share buybacks by Intel, returning value to shareholders and supporting the stock price to some degree. The stock repurchases not only help buy shares from the outstanding float, but the decreasing amount of shares becomes more valuable because the earnings per share increase due to the reduced float.

Intel’s dividend is strong and sustainable, as other contributors have noted. The payout ratio is only about 30% of the company’s earnings. A low payout ratio is attractive as an investor would like to know that the dividend is sustainable and hopefully can increase over time. The dividend yield at the current 3.52% is higher than both the 10 year yield at 1.93% and the 30 year bond yield at 2.93%. Many analysts are pounding the table for equities because many dividend yields are now higher than treasury interest rates. One must remember that interest rates are very low historically speaking, and low rates do not require stock prices to go up. In fact, the low rates have been engineered by a Federal Reserve in response to a weak economy and falling stock prices. But if one is comfortable with the outlook of a stock with a decent yield like Intel, then, in a good stable year it could be more profitable to hold dividend payers than cash and fixed income.

Thanks to that yield, Intel currently is a “Dog of the Dow” by having oneof the top 10 dividend yields in the Dow. Being a Dog will certainly bring attention from prospective income and value investors looking for yield. In addition, by having a low price of the top 10 Dow dividend payers, Intel qualifies as a “Small Dog”. Statistically the Dogs of the Dow at least perform with the market if not outperform the market while getting paid to be an owner with a higher than normal dividend yield. The “Small Dogs” of the Dow, being usually more volatile, are supposed to outperform both the S&P 500 and the Dogs of the Dow in good years, but may do poorly due to the volatile nature in a down market. Given the fact that Intel is named a Dog of the Dow will attract investors merely for this fact, creating some artificial demand that might otherwise not be there. Being a Dog of the Dow is not a reason alone, nor a guarantee that a stock like Intel should go up in stock price, but it will be a reason for buyers to consider Intel when the overall market is down and searching for quality dividends.

In light of Intel’s decent valuation, but in respect of the global macro market, we might consider strategies other than outright buying INTC at the market price. For someone who likes Intel at the current 23.84 and 3.52% dividend yield, I would urge them to consider the idea of selling cash secured puts to improve their entry point. Waiting for a period of bad weeks or months in the market would create the best opportunity for entry, of course, but even today one could see the benefits of selling puts 3 to 6 months out. When one sells or writes a put, they are paid a premium to buy at predetermined price. As of today, the July 2012 $20 strike puts trade for 0.87, meaning a seller would collect $87 dollars to buy 100 shares Intel stock at $20 a share for a net cost of 19.13 per share (before commissions) and an approximate dividend yield of 4.38%. In this example, if the price never reaches 20 dollars by the July expiration, only the premium is earned and the option writer may not be obligated to buy the stock. In the event that the investor is not required to buy the stock, the premium earned would still be worthwhile when compared to the cash reserved to buy Intel, a yield of 4.35% premium to cash. Of course there are many variations to this strategy and one would have to take into consideration their own financial circumstances and goals before deciding on any strategy, but surely the idea of owning a strong dividend payer at a lower price sounds interesting to most investors on the fence or in the “wait and see” mode. Given the potentially sideways outlook for Intel in 2012 and the chance of a better entry price in a soft market, strategies to buy Intel lower seem to be the way to go.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.