Qualcomm: Inexpensive Valuation Warrants A Buy

Jan.14.13 | About: Qualcomm Inc. (QCOM)

Shares of Qualcomm (NASDAQ:QCOM) have returned 16.4% over the past 12 months. At $64.89 per share, the stock is now trading near its 52-week high of $68.87 attained in March 2012 and offers a dividend yield at 1.5%. In this article, I will walk you through my stock valuation analysis which may assist you in formulating investment decisions.

From a relative standpoint, Qualcomm's valuation appears to be tempting based on the company's solid financial performance relative to its peers (see comparable analysis chart below). Sell-side analysts on average predict the firm's revenue, EBITDA, and EPS to rise by 2-year CAGRs of 9.3%, 7.9%, and 11.0%, respectively, over the current and next fiscal years. Both Qualcomm's revenue and EBITDA growth estimates are considerably above the averages of 5.5% and 5.7%, for Texas Instruments (NYSE:TXN) and Broadcom (BRCM), respectively. However, the firm's EPS and EBITDA margin growth rates are projected to be lower than its peer averages. On the profit side, Qualcomm has demonstrated a robust margin performance as all of the company's margin and capital return metrics are markedly above the par. The company carries almost no debt compared to the peer average debt to capitalization and debt to EBITDA ratios of 25.9% and 1.4x, respectively. In terms of liquidity, Qualcomm's trailing free cash flow margin of 23.9% is above the peer average. Both the company's current and quick ratios are above the par, reflecting a solid balance sheet performance.

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To summarize the financial comparisons, Qualcomm's healthy growth potential, robust profitability, lower leverage, and liquid balance sheet should justify a solid stock valuation premium relative to the peer-average level. Nevertheless, the current stock valuations at 10.0x forward EV/EBITDA and 15.0x forward P/E represent an average valuation discount of 4.9% to the peer-average trading multiples, and the stock's PEG ratio of 1.0x is far below the peer average at 1.6x (see chart above), suggesting that Qualcomm is somewhat undervalued.

Moreover, Qualcomm's forward P/E multiple of 15.0x is currently trading at only 7.3% premium over the same multiple of the S&P 500 index at 14.0x (see chart below). I believe the stock should reasonably command a higher market premium provided that 1) Qualcomm's consensus estimated long-term earnings growth of 15.0% is substantially above the average long-term growth of the S&P 500 companies at just 8.0%; 2) Qualcomm has a fortress-like balance sheet with low leverage and ample liquidity; 3) The company is a cash-generating machine with a free cash flow margin above 20%; and 4) Qualcomm has a dominant position in the LTE market.

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To further support my view, I also performed a DCF analysis which incorporates the market's consensus revenue and EBITDA estimates from fiscal 2013 to fiscal 2015 (see DCF chart below). Other free cash flow related items including depreciation, tax expense, capital expenditure, and net working capital investment are projected based on their historical figures relative to the revenue as those ratios have been trending steadily over time. Annual revenue growth from fiscal 2016 to terminal year is assumed to gradually decrease to 2.5%, which is close to the rate of inflation, and EBITDA margin in that period is forecasted to remain stable at the 40.1% level.

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A company-specific risk premium of 3.0% is applied in the cost of equity calculation to account for the above financial projection risk. Instead of using the currently depressed 10-year U.S. Treasury Bond yield, a normalized 10-year risk-free rate of 2.5% is used. As such, based on a WACC of 10.5%, a terminal growth rate of 2.5%, and an implied terminal EBITDA multiple of 9.0x, the DCF model yields a stock value of $72.02, which is 11.0% above the current share price of $64.89, indicating an undervalued share price given that the model assumptions appear to be fair. In addition, the DCF sensitivity tables suggest that the stock value would only decrease to $61.99 if the WACC is lifted to 12.0% with an unchanged terminal growth rate at 2.5%. On the other hand, based on the same terminal growth rate at 2.5%, a decrease in terminal EBITDA margins to 36.1% would only reduce the stock value to $67.12. Both scenarios imply a solid margin of safety on Qualcomm's share price.

On the qualitative side, Qualcomm's growth prospects remain solid. Credit Suisse' research analyst, Kulbinder Garcha, elaborated on his long-term bullish view in a recent research note (sourced from Thomson One, Equity Research):

Our extensive review of both the mobile handset and chipset markets leads us to believe that Qualcomm is set to benefit from its heavy levels of historic investments in LTE, providing an enduring competitive advantage. This, along with rising smartphone growth, should drive a LT EPS CAGR of 19%...(For QCT segment) Based on our proprietary wireless scorecard, we conclude that QCT is set to dominate the baseband market long term. Specifically, we highlight the company's dominant LTE lead, strong IPR position, and exposure to the "right" customers (Apple/Samsung). Through a detailed technology, customer and product roadmap analysis, we demonstrate that revenue share is set to expand to 44% long term from 39% in 2012. Further, with such scale and dominance, our current QCT margin estimates at 19.1%/19.6% could prove conservative…(For QTL segment) We see support from: 1) smartphones driving volume growth of 16%/15% in FY13/14; 2) continued strength in ASPs (+6%/-1% in FY13/FY14) as the >$400 device market is being driven to unprecedented levels; and 3) scope for upside as we exclude licensing opportunities from the 3G white label market and small cells.

Bottom line, given Qualcomm's healthy growth prospects, attractive valuation level, as well as the investment's solid margin of safety, I recommend acquiring the shares now.

The comparable analysis and DCF charts are created by the author, all other charts are sourced from Capital IQ, and all historical and consensus estimated financial data is sourced from Capital IQ unless otherwise specified.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in QCOM over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.