Previously on Qualcomm (QCOM), I wrote that I was thinking of the $65 zone as an accumulation zone and the $100 per share zone as a distribution zone. I continue to agree with that assessment and the new research that I have included in this report adds to the bullish case for Qualcomm.
Specifically, the industry is far from saturation and could triple by the end of the decade. This leaves Qualcomm well positioned to increase revenues in a growing market. Also, the valuations of the firm are compelling given its growth rate and profitability.
At a PEG of 1.3, a price/book of 3.5, a price/earnings of 19 and a 10-year growth rate of about 20%, buying shares of Qualcomm is close to a "no-brainer."
I'm bullish on all of Qualcomm's operating segments - the reader probably already knows that Qualcomm is strategically well positioned in QCT and QTL. Gartner is forecasting global smartphone shipments to increase from 700M in 2012 to 1.8B in 2017, which is an excellent tailwind for the valuation of Qualcomm. Currently, 3G and multimode 3G/4G connections account for only 34% of total cellular connections, which means that there are plenty of buyers left in the market. But the QCT segment's customer base is concentrated, which limits Qualcomm's pricing power.
The trend is toward chipsets that integrate many of the essential components of the mobile device into a unified and optimized system-on-a-chip, which includes a modem, a CPU, a graphics processing unit, multimedia support and other components that work together. Qualcomm is very well positioned in terms of its chip designs.
Qualcomm's fabless production model means that the firm has less net plant, property and equipment than it otherwise would if it owned fabs. I view this as having a negative impact on the valuation of the firm.
From a profitability perspective, Qualcomm is definitely generating a residual income as the company's return on invested capital is higher than its cost of capital. The leader in 3G and 4G technology has recovered well from the global financial crisis. But while resource utilization is generally up over its pre-crisis levels, Qualcomm has become somewhat less efficient since the end of fiscal 2011. Specifically, receivables turnover is down, but asset turnover and inventory turnover are up.
Intel and Qualcomm have similar gross margins and Broadcom has the lowest gross margin. Qualcomm has the highest operating income margin on lower SG&A expenses; it is worth noting that Broadcom spends the highest percentage of revenues on R&D, which translates to the highest growth rate. As a Broadcom shareholder, I think that is fantastic. From an income statement profitability perspective, you want to be long Intel and/or Qualcomm.
But on a price/book value basis, Broadcom has the lowest valuation and the highest growth rate. The same thing can be said for sales; the market is saying that Broadcom's sales are worth less than Intel's and Qualcomm's sales. At the same time, investors are paying more for shares of Qualcomm than for shares for Intel, which would be attributable to the growth rate differential and the outlook for the businesses. In terms of relative valuation, I'm happy that I am overweight Broadcom relative to Intel and Qualcomm, but I will go into more depth with regard to Qualcomm's valuation to see if I should get long shares.
It should be clear that the industry and business fundamentals are bullish for the valuation of Qualcomm, but is the valuation bullish for the valuation of Qualcomm?
I expect the cash dividend to be increased to the $0.40 to $0.45 per share range in March 2014, which implies a 14%-28% dividend growth rate. Clearly that is not sustainable. But to talk high level about a dividend valuation, the growth rate would exceed the cost of equity which implies an infinite valuation. Obviously, that is not economic reality and modeling a sustainable growth rate for this firm is too inaccurate of a valuation.
So based on the multiplier models, Qualcomm is undervalued relative to its 5-year averages. The PEG is 1.3, which is equal to Broadcom's PEG; I think this means Qualcomm's valuation has some upside potential. Also, 19 times earnings and 3.5 times book is a reasonable price to pay for a company with Qualcomm's growth rate and industry outlook.
Based on the historic high and low ranges, I think it makes sense to put my back against the $60 per share level and get long.