Intel Slashed By Morgan Stanley In Sizzling Note Doubting Near Term Performance

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Chip manufacturer Intel Corporation's price target has been downgraded by investment bank Morgan Stanley in a fresh not that hit the waves earlier today. Intel is in the midst of hefty capital spending as it looks to catch up in the semiconductor manufacturing sphere, and Morgan Stanley believes that this will impact the company's cash for the next couple of years. The bank also believes that when combined with the expected weakness in Intel's share price, the company is replaced by other attractive offerings such as another Santa Clara, California based chip manufacturer GlobalFoundries, Inc.

Intel's Aggressive Capital Spending Has Created "All Or Nothing" Situation Argues Morgan Stanley

The note starts off by cutting Intel's share price target by an eye-watering 14.5% as Morgan Stanley drops its value estimation of the chipmaker to $47/share from an earlier $55/share. It then proceeds to provide several reasons behind the decision that saw Intel's shares drop by as much as 2% in premarket trading today (the stock opened at $48.16 today after it closed at $48.87 yesterday).

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Firstly, Morgan Stanley believes that the next couple of years will prove to be far from consistent for the company. As outlined by SeekingAlpha, the analysts stated in the research note that:

"We like new CEO Pat Gelsinger and believe in the longer term turnaround capability in the core business, but even with that view, the next couple of years are likely to see the stock move sideways and we see more actionable opportunities elsewhere in our coverage."

They went on to note that heavy capital investment will harm Intel's free cash flows. In financial terminology, the free cash flow of a firm is the amount it generates in a time period after non-cash expenses such as depreciation are accounted for. This enables analysts to estimate the money immediately available to investors in the form of dividends should the company decide to pay all of it back. However, in reality, most of the company's net income, which is the amount left after the non-cash expenses are deducted, is reinvested in a firm for growth.

Morgan Stanley also shared some optimism for Intel, stating that the strategy that the company is currently on stands a good chance of it being able to get its core business on track. However, it also cautioned that the dual-edged attempt of improving the core business and investing heavily in the foundry space creates an "all or nothing" situation for the company, as it has to perform on both ends to ensure each can deliver maximally. Without a strong core business, Intel carries the risk of overspending in chip manufacturing, while without strong manufacturing, it risks leaving demand untapped and at the mercy of its smaller rival Advanced Micro Devices, Inc (AMD).

Chipmaker GlobalFoundries (GFS) is a relatively safe investment when compared to Intel outlined analyst Joseph Moore. As quoted by StreetInsider, he believes that:

“While INTC is betting big on its foundry business, and recently purchased a smaller foundry in Tower Semiconductor, GFS already has a strong and growing customer base based on proven know-how and manufacturing capability.”

Commenting on the free cash flow, he added:

“The aggressive investment in capacity in pursuit of revenue growth opportunities in foundry and graphics point to minimal free cash flow in the next couple of years - as guided, to be clear - but also drive a substantial increase in the underlying components of cost of sales (depreciation, labor, and overhead seem likely to rise 40%+ in the forecast horizon, in contrast to sales growth that's forecasted to be negative this year and low single digits next year).”

Intel's chief global operations officer Mr. Keyvan Esfarjani elaborated the company's investment strategy at an investor day held last month. He explained that Intel is pursuing an approach that balances the "all or nothing" scenario outlined by Morgan Stanley. According to Mr. Esfarjani, this will ensure that Intel only brings production capacity online when the demand requires - and not sooner or later.