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Thinking About a Dividend Hike? Think Again

Wednesday - 8/21/2013, 7:13am  ET

The "death of the PC" is a cliche that you hear all too often these days, and with its large exposure to the PC market, semiconductor giant Intel has seen its revenue and profit drop on a year-on-year basis. One sign of Intel's recent struggles is the company's recent dividend announcement, when Intel kept its dividend on hold despite wide expectations of a dividend hike.

Where's my dividend hike?

You only have to look at Intel's dividend history to see why investors were expecting a bump in the quarterly dividend. Intel has a rich history of dividend increases: The tech giant increased its quarterly dividend from $0.14 per share in fourth-quarter 2009 to $0.225 per share in the third quarter of 2013, an increase of more than 60% over 11 quarters. During the past decade, the only time that Intel did not raise its dividend at least once every four quarters was during the great recession of 2008-2009 when it kept its quarterly payout on hold at $0.14 per share for seven quarters.

A dividend hold makes sense

Although many investors were expecting a dividend hike based on Intel's dividend history, Intel's decision makes sense when you look at the company's recent earnings results and the management's previous comments about its target payout ratio.

Intel's latest earnings results show that the company is facing the consequences of ignoring the trend-shift toward mobile computing for too long. In its second-quarter results, Intel reported an EPS of $0.39, down 28% year-on-year. The company's revenue came in at $12.8 billion, down 5% year-on-year. Thus, with falling revenue and profit, it would not have made sense for Intel to commit to increasing payouts to investors.

The importance of Intel's falling revenue and income to the company's dividend decision is accentuated when you look at the company's payout ratio. Intel already pays a larger proportion of its income as dividends as compared to many of its peers. In the past 12 months, Intel earned $9.5 billion in net income and paid around $4.5 billion in dividends, resulting in a payout ratio of over 48%. Over the same period, chip maker Qualcomm had a payout ratio of 29%, while tech giants Microsoft and Cisco Systems had payout ratios of 34% and 29%, respectively.

Looking at Intel's dividend payments as a percentage of the company's Free Cash Flow (FCF) also shows why the chipmaker failed to raise its dividend. Intel's CFO Stacy Smith has been on record to state that the company targets to pay around 40% of its FCF in dividends. The chart below shows Intel's dividends paid as a percentage of its FCF over the past six years.

The chart shows that for the year 2012, Intel's dividend payout as a percentage of its FCF was at a historic high of 57%, much higher than the management's stated objective of 40%. Looking at this chart in perspective of Intel's dividend history, you can see that dividend increases come only when the FCF payout is close to or below management's stated target of 40%.

Assuming that Intel's FCF for the year 2013 remains the same as that in 2012, which is a generous assumption given that analysts expect the company's revenue and net income to fall, Intel's FCF payout ratio would still remain above the 50% mark despite the company keeping its dividend on hold. This is much higher than the management's stated target and shows why the company chose not to increase its dividend.

So what next for Intel?

Although Intel does not have much room to increase its dividend anytime soon, I believe that Intel's future is not as bleak as some of the bears might suggest.

Intel's leadership in the PC industry is already well established and will only be enhanced by the introduction of its latest processor, codenamed Haswell, which brings remarkable improvements in battery life and graphics performance over its predecessor.

Moreover, Intel claims that its latest chips designed for mobile that are based on the Silvermont architecture are superior to those designed by rival ARM Holdings in terms of power and performance, a claim that ARM vehemently rejects. Only time will tell who is right, but with Intel's renewed focus on developing mobile chips, I have no doubt that Intel can translate its huge advantages in manufacturing process and R&D to crush its competitors in mobile as well.

But I want dividend growth...

Despite my bullish view Intel's long-term prospects, there are some investors who might not wish to wait too long for their dividend hike. Such investors can look at Microsoft and Cisco Systems as alternative large-cap tech names that pay a healthy dividend.

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