Qualcomm: Buy For Growth, Stay For The Dividend

Mar. 4.14 | About: Qualcomm Inc. (QCOM)

Shares of Qualcomm (NASDAQ:QCOM) popped over 2% on the news the company was increasing its dividend and buyback (press release available here). With a fantastic balance sheet and strong cash flow, Qualcomm has the capacity to continue returning capital over the coming years. QCOM is now a capital return and a growth story, which is why I am very bullish on the stock. Many investors say dividends pay you to wait as a company tries to find a way accelerate growth. In Qualcomm, there is nothing to wait for, but you get paid anyway.

Qualcomm raised its quarterly dividend by 20% to $0.42. Shares now yield roughly 2.2%. Qualcomm also raised its buybacks authorization by $5. Including the residual value of the existing plan, Qualcomm can repurchase about $7.8 billion or approximately 5.5% of outstanding shares at current levels. In the first fiscal quarter, QCOM repurchased $1 billion in stock (financial and operating data available here). In the press release, QCOM says it has bought back $2 billion so far in the fiscal year, which means it has repurchased another $1 billion in the past two months. Qualcomm is aggressively returning cash to shareholders. In the past five months alone, QCOM has repurchased 1.5% of all shares.

Now, Qualcomm has a long-term goal of returning 75% of free cash flow to shareholders. In fiscal 2014, Qualcomm will generate operating cash flow of $8.5-$9 billion, which should translate to free cash flow of roughly $8 billion. At the 75% goal, QCOM should target $6 billion in capital returns. With about 1.69 billion shares outstanding at the moment, the dividend over the current fiscal year will cost about $2.6 billion. This would suggest QCOM could spend $3.4 billion in buybacks, or only another $1.4 billion from here until the end of the fiscal year.

In reality, I expect Qualcomm to keep a $1 billion-$1.25 billion per quarter pace, even though this is slightly above target. Qualcomm has too much cash on its balance sheet (though much is trapped offshore) and should work to gradually reduce its hoard to under $20 billion. While over the long term a 75% payout ratio is an aggressive and sustainable goal, Qualcomm should actually pay out more cash than it generates now to normalize its cash hoard. The best avenue for this is a buyback when the shares are attractive as they are now. At the end of last quarter, Qualcomm had $31.6 billion in cash, which amounts to $18 per share. Clearly, Qualcomm has the financial flexibility to return a significant amount of cash to shareholders over time.

Qualcomm's dividend hike and new buyback authorization are a sign the company is serious about maximizing shareholder value. Now over the long run, capital returns are determined by operating performance. The only way to keep raising the dividend and repurchasing stock is to grow earnings and cash flow. Qualcomm is doing this thanks to its leading mobile technology and chips. With smartphone sales continuing to grow around the world, Qualcomm has a long runway of growth, especially with China rolling out LTE this summer. China could provide an incremental 100 million devices next year. New devices like smart watches and machine to machine communication provide Qualcomm with further chip and licensing potential.

In fiscal 2014, I expect revenue growth of at least 8% to $26.5-$27.5 billion and earnings per share of $5.10-$5.20. With a full year of LTE in China, I do expect revenue and earnings growth to actually accelerate in fiscal 2015 at up 10%-12%. Qualcomm is the premiere way to bet on the mobile revolution, as it benefits no matter which smartphone manufacturer is winning market share because QCOM gets revenue from most devices.

Qualcomm shares should conservatively trade at 15x earnings on an ex-cash basis. This suggests a fair operating value of $76-$78. Once we add back the cash hoard, Qualcomm is worth roughly $95, which represents 25% upside from current levels. Qualcomm will continue to return cash to shareholders and grow the bottom line. Its share do not adequately reflect its growth prospects, and I would be a buyer here.

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.