Intel (INTC) is the epitome of tech dominance, with a better than 80 percent share of the semiconductor market. But it had become an uphill struggle for Intel to translate its market dominance into brisk earnings growth.
In the past few months, however, Intel�s earnings outlook has sharply improved. Why? The explanation lies in a momentous turnaround in how transistors are priced.
Until recently, Intel was battling a decades-long trend: the steady decline in chip prices, which ironically had been brought about mainly by Intel�s own amazing technological prowess.
While people around the world were eagerly buying computers, phones, tablets, and other devices built around Intel�s ubiquitous chips, Intel kept finding ways to make its chips ever smaller and more powerful, thereby continually pushing average selling prices down.
This encouraged the explosive spread of new technologies and of the Internet. But it also meant that Intel�s massive investments in research and development weren�t rewarded by fast-paced earnings growth.
Now, though, microprocessor prices have finally started to rise, and with them Intel�s fortunes. As reported by technology research firm IDC, average selling prices for PC microprocessors rose by 9 percent in 2011, their second year in a row of significant growth.
Manufacturers of computers, servers, and mobile devices all are paying more for the innards of their products, and those higher prices will funnel right to Intel�s bottom line (probably passing on to consumers as well).
With its dominant market share, Intel comes close to being a monopoly. True, Advanced Micro Devices, with a market cap of $5.5 billion, supplies the 20 percent or so (depending on the particular chip segment) of the market that Intel chooses to leave on the table.
But with such deep pockets (roughly $15 billion in cash and short-term investments as of yearend 2011), Intel could easily price AMD out of the market.
We expect, however, that Intel will be content to continue to throw AMD a bone so as to avoid arousing the ire of consumers and government antitrust lawyers.
Intel�s highest market share�better than 90 percent�is in server processors, which happens to be the fastest-growing chip segment. Server processors account for just 20 percent of Intel's sales but are growing three times as fast as desktop processors.
The outlook over the next few years is exceptionally positive for unit sales of server processors as demand for cloud servers, networking, and storage continues to rise dramatically.
The servers are what allow users to store data in the �cloud� rather than on their individual devices; it�s estimated that for every 120 tablets or 600 smartphones, an additional server is required.
Despite Intel�s market leadership, outright dominance in the fastest-growing areas, and the favorable newfound pricing dynamics for its products, the shares are still surprisingly cheap.
Even after a recent run-up they trade at just 11 times current-year earnings estimates and at 10 times anticipated 2013 earnings.
And that�s based on consensus estimates of 10 percent earnings growth. We think Intel could tack on a few extra percentage points to growth, bringing its PEG to below 1.
The yield of 3 percent adds further to the shares� appeal, making this an investment for growth and income investors alike.
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