Qualcomm: Promising Growth Prospects With On-Sale Valuation

| About: Qualcomm Inc. (QCOM)

The share price of Qualcomm (NASDAQ:QCOM) has an almost flat performance year to date and is currently trading off from its 52-week high of $68.50 achieved in March. I believe the stock is a strong buy at the moment given the significant margin of safety on the investment. My view is backed by the following reasons:

1. Qualcomm shares are very cheap relative to its peers including Broadcom (BRCM) and Texas Instruments (NYSE:TXN) (see chart below). The company's consensus revenue, EBITDA and EPS estimates generally outperform the averages for the comps. On the profit side, Qualcomm also demonstrates a superior performance as its various margin and capital return metrics are considerably above the peer benchmarks. In terms of leverage and liquidity, the firm carries no debt load and its free cash flow margin is fairly in line with the comps' average. Both Qualcomm's current and quick ratios are substantially above par, reflecting a very healthy balance sheet condition.

Given the financial strengths in almost every aspect, I believe Qualcomm should reasonably command a premium valuation over the comps' level. Nevertheless, the shares' price multiples at 10.0x forward EBITDA and 14.1x forward EPS (next 12 months) both trade at a slight discount to the same comps multiples. After accounting for Qualcomm's above-average 5-year EPS growth estimate, the stock's PEG ratio of 0.9x is even 36% below the peer average at 1.5x, suggesting Qualcomm is somewhat undervalued relative to its peers in terms of financial performance (see chart above).

2. Market's consensus estimates for Qualcomm's revenue, EBITDA, and EPS for the current and next fiscal years have experienced multiple upward revisions over the past 12 months, and their current levels are notably above the historical figures in 12 months ago (see charts below).

Despite the positive consensus estimate trend, the stock's forward P/E multiple has compressed by 11% from 15.9x to 14.1x over the past 12 months, and it is now trading at a 4% discount to the same multiple of S&P 500 Index (see chart below).

Qualcomm's below-market valuation appears to be exaggerated as the stock's fair value should trade at a premium over the market level based on the following facts:

  1. Qualcomm has been trading at an average of 11% premium over the market over the past 12 months and its growth prospects remain solid as reflected by the rising consensus estimate trend;
  2. The company's 5-year EPS growth estimate at 15.1% is overwhelmingly above the average estimate of 8.2% for the S&P 500 companies;
  3. Qualcomm also offers market-leading profitability and free cash flow margins;
  4. The firm has a fortress-like balance sheet with no debt and a significant cash balance, which represents approximately 12% of the current market capitalization; and
  5. Qualcomm's 2.2% forward dividend yield is almost in line with the average yield for the S&P 500 Index, and its share price also gets a solid support from the firm's share repurchase program.

3. Analysts are very bullish on the stock. Of the total 44 ratings compiled by Thomson One, there are 14 strong buy and 24 buy ratings, and the market's average 1-year price target of $76 is 19% above the current share price. According to a Sterne Agee research note released on April 9, Vijay Rakesh commented on his view for the company's current and next-quarter performance, which I tend to agree with (sourced from Thomson One, Equity Research):

We believe there could be MarQ upside depending on the S4 builds in the quarter…We believe QCOM will pick up significant smartphone share on multiple platforms into 2Q/June. There have been numerous reports that QCOM could supply up to 70% of the Galaxy S4s, supplying to both U.S+European S4 models versus only U.S. on the prior S3 platform. With almost 10M+ S4 sold on pre-orders, tracking better than S3, QCOM should see a good tailwind. Also, while last year, the 8960 ramp saw competition from NVDA Tegra3 at HTC, LG, etc., this year with the Snapdragon 600 it seems to be a clean sweep with Samsung, HTC, LG and ZTE all using the 600, and increasing share globally at multiple OEMs. Also, we believe the iPhone5S ramping late in 2Q13 should be another tailwind.

Bottom line, in the light of Qualcomm's solid financials, promising growth prospects, as well as its cheap valuation, the downside risk appears to be limited. Investor may even consider loading up some shares before the company's earnings release on April 24, as the chance for an upbeat result is likely higher due to the building of Galaxy S4.

All charts are created by the author except for the consensus estimate tables, which are sourced from S&P Capital IQ, and all financial data used in the article and the charts is sourced from S&P Capital IQ unless otherwise noted.

Disclosure: I am long QCOM. 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.