Qualcomm (QCOM) shares rallied 2.5% after the bell on Wednesday after the company reported fiscal first quarter results (press release available here). While this quarter offered both some good and bad news, investors were clearly focusing on the good news, helping shares recoup some recent losses. Shares had dropped 5% in the five trading sessions prior to this announcement because Samsung and Apple (AAPL) both reported disappointing phone sales, which left investors concerned about Qualcomm's chip business. This negative sentiment lowered expectations, which is likely why investors were relieved that QCOM's numbers were not that bad. In my opinion, Qualcomm remains the premiere way to invest in the mobile revolution, and I continue to be optimistic after seeing these results.
In the first quarter, Qualcomm earned $1.26, which beat expectations of $1.18. However, revenue of $6.62 billion was below the $6.69 billion consensus. Qualcomm revenues were up 10% year over year while earnings per share were flat. Operating cash flow continues to impress and came in at $2.78 billion or 42% of revenue. As a consequence, QCOM continues to aggressively return capital to shareholders with $1 billion in repurchased stock and its quarterly dividend of $0.35, which costs $590 million per quarter. The company also shipped 213 million MSM chips, which was up a strong 17% year over year.
Qualcomm continues to invest in research and development to maintain its leading position in wireless technology and fend off potential challenges from the likes of Intel (INTC) and others. On a GAAP basis, R&D spending was up 20% year over year to $1.328 billion. As a consequence, R&D accounted for 20% of revenue compared to 18% last year. With advancement in China's network and a potential growth in healthcare, autos, and wearable technology, this spending could reap significant dividends in coming years. Moreover, the company maintains cost discipline with SG&A as a percentage of revenue falling from 10% to 9%.
In this quarter, Qualcomm continued to be immensely profitable and had surprisingly strong smartphone shipments in light of recent quarterly reports from handset makers. However, Qualcomm's guidance was especially interesting. For the last three months, Qualcomm has been saying 2014 will be an extremely back-loaded year due to the launch of China LTE. As a consequence, while Qualcomm's second quarter guidance was weak; its full year guidance was relatively strong.
In the second quarter, Qualcomm expects to generate $6.1-$6.7 billion and earnings of $1.15-$1.25. Analysts were looking for $1.26 and $6.72 billion in revenue. However, Qualcomm maintained its full year revenue guidance of $26-$27.5 billion while upping its EPS guidance by a nickel to $5.00-$5.20. This EPS guidance assumes Qualcomm continues to repurchase about $1 billion in stock every quarter, which is in-line with its goal to return 75% of free cash flow to investors through buybacks and dividends. This full year EPS guidance is one penny ahead of expectations for $5.09 while Qualcomm should grow revenue by a solid 8%. Importantly, 2015 should be a strong year as Qualcomm gets a full year of benefit from the China LTE rollout, growing sales in tablets, and the potential for wearable devices.
With its pledge to return 75% of free cash flow to shareholders, Qualcomm is as much a capital return story as it is a growth story. In 2014, Qualcomm should generate over $8.5-9 billion in operating cash flow, which should translate to about $8 billion in free cash flow. Now in addition to the cash flow its business is generating, Qualcomm also has a pristine balance sheet with $31.6 billion in cash, though much of this total is trapped overseas. Still with this hoard, QCOM can safely continue to return this level of cash flow to shareholders. Its cash balance also amounts to about $18 per share. Given its pristine balance sheet, unparalleled technology, and exposure to the growing smartphone sector, QCOM should trade at least 15x earnings on an ex-cash basis. Using management's midpoint, shares should trade to $95.
Investors should also be aware that Qualcomm has undergone a management transition with Steve Mollenkopf taking over as CEO while Paul Jacobs remains Chairman of the Board to ensure a smooth transition. I think Jacobs has kept guidance conservative to ensure Mollenkopf beats estimates in his first year on the job and expect earnings of $5.20-$5.30 this year. Investors should note that China is investigating Qualcomm for anti-trust activity, though this action is likely a political one aimed at getting a better licensing rate and should have minimal long-term implications.
With the smartphone market poised to keep growing, especially in emerging markets, wearable technology likely to increase penetration in developed markets, and efforts to connect autos and healthcare wirelessly, Qualcomm should deliver double digit earnings growth over the next five years. With a long runway of growth, Qualcomm shares are extremely cheap here. Any investor who expects continued growth in the wireless connectivity and smartphones should be a buyer of Qualcomm at current levels. Shares could rally another 30% to the mid-$90s before approaching fair value.