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Summary

  • The intrinsic value estimate is $98 per share.
  • 2014's product introductions should drive strong performance.
  • The technicals remain bullish.

Qualcomm Incorporated (NASDAQ:QCOM) is releasing the latest versions of its Snapdragon chipsets into a smartphone market that is expected to grow at a 20% CAGR through 2017. The 200 series is the entry-level offering that features extended battery life. The 400 series is the mass-market offering, which is 64-bit. The 600 and 800 series are feature rich and designed for high-end devices. The new releases, a lack of competition, and key design wins, such as Samsung's Galaxy S5, should drive revenue growth in fiscal 2014.

The worldwide transition from 2G to 3G and 3G/4G is expected to continue, including the further expansion of 3G and 3G/4G in emerging markets, such as China. Consumer demand for advanced 3G and 3G/4G multimode devices, including smartphones and data-centric devices, is likely to continue at a strong pace. Also, the issuance of 4G operator licenses in China will encourage competition and growth. Lastly, strong growth of device shipments in emerging regions is expected to continue, adversely impacting the average and range of selling prices of 3G/4G devices.

Simply put, QCOM is the industry leader in a growing market, and although competition and market dynamics (lower ASPs) will adversely impact profitability over the medium to long term, the near-term outlook is favorable.

Recent Developments

  1. Derek Aberle has been promoted to president of Qualcomm; he has been with the firm for 14 years.
  2. The company increased its quarterly dividend by 20% and its share buyback program by $5 billion to $7.8 billion.
  3. QCOM's Snapdragon will power the Samsung Galaxy S5 and Samsung Galaxy Grand 2; the design win in the Galaxy S5 confirms what was previously a rumor.

Business Summary

Qualcomm Incorporated is a leading developer and innovator of advanced wireless technologies, products, and services. The company develops digital communication technology called CDMA and owns intellectual property applicable to products that implement any version of CDMA including patents, patent applications and trade secrets.

In the last report, I was looking to see if the profitability continued to deteriorate in the first fiscal quarter - it did. Relative to the prior year, the gross margin declined from 62.8% to 59.1%. The operating margin declined from 34.7% to an adjusted 30%. The net profit margin also declined. The decrease in profitability was partly attributable to a decline in the QCT margin percentage, which was partially a result of lower average selling prices and an unfavorable product mix.

For the year ending (in millions except per share data):

2012-09

2013-09

2014-09E

2015-09E

Revenue

$19,121

$24,866

$28,596

$32,027

Gross profit

$12,025

$15,046

$16,586

$18,256

Operating income

$5,682

$7,230

$8,007

$8,808

Net income

$6,109

$6,845

$7,435

$8,167

Diluted EPS

$3.51

$3.91

$4.36

$4.79

I think of the growth rate as slowing and profitability as deteriorating. Revenue is forecasted to increase 15% in fiscal 2014 and 12% in fiscal 2015. Gross margin in the model is impacted most by the transition to 3G/4G multimode. With gross margin declining to the upper 50s, the operating margin dips below 29%, and the net profit margin dips below 27%. The absolute profits are forecasted to increase.

2011-09

2012-09

2013-09

2014-09E

2015-09E

Ending financial leverage

1.35

1.28

1.26

1.24

1.22

Cash ratio

2.20

2.33

2.87

--

--

Defensive interval

913 days

796 days

800 days

--

--

The liquidity appears ample and the solvency position appears solid. The defensive interval was 800 days at the end of fiscal 2013 and QCOM was not carrying any debt. Consequently, the firm has sufficient capital to return to shareholders or to make acquisitions. Also, QCOM could issue debt and decrease its weighted average cost of capital. For now, the financial leverage ratio is forecasted to decline to 1.22 at the end of fiscal 2015.

For the year ending (in millions):

2011-09

2012-09

2013-09

2014-09E

2015-09E

Cash flow from operations

$4,900

$5,998

$8,778

$9,437

$10,569

Capex

$593

$1,284

$1,048

$1,100

$1,300

FCFF

$4,307

$4,714

$7,730

$8,337

$9,269

FCFE

$4,307

$4,833

$7,825

$8,337

$9,269

Common share repurchases

$142

$1,313

$4,610

$5,000

$5,000

Dividends paid

$1,346

$1,583

$2,055

$2,600

$2,900

The forecast is for continued strong cash flows growth. Capex is expected to increase in the coming years, which is in line with the growth of operations. Free cash flow to the firm is expected to increase 14% in fiscal 2014 and 12% in 2015. Overall, continued demand for 3G and 4G solutions, particular in the emerging markets, is forecasted to drive strong cash flow growth.

The second half of fiscal 2014 should be better than the first half as QCOM benefits from the rollout of LTE in China. The Snapdragon 400 series, which is a mass-market 64-bit solution, is expected to contribute to cash flow growth. Also, the entry-level 200 series Snapdragon should gain traction with emerging market consumers. At the higher end, the 600 series and 800 series should continue to be integrated into feature devices through 2014, such as the Samsung Galaxy S4, S5 and HTC One. The investigation into the possible violation of monopoly laws in China is a key risk worth mentioning.

Risks

  1. The share price is likely to remain volatile and investors could lose a portion or all of their investment.
  2. Investors should judge the suitability of an investment in QCOM in light of their own unique circumstances.
  3. A decline in the global economic growth rate and/or a decline in the pace of economic growth in the United States could adversely impact the results of operations and the share price.
  4. The technology industry is characterized by rapid technological change, which could materially adversely impact the results of operations.
  5. Competition in product development and pricing could adversely impact performance.
  6. Incorrect forecasts of customer demand could adversely impact the results of operations.
  7. Higher interest rates may reduce demand for QCOM offerings and negatively impact the results of operations and the share price.

This section does not contain all risks related to an investment in QCOM.

Portfolio And Valuations

(click to enlarge)

QCOM is in an intermediate and primary degree bull market. But there are latent signs of weakness, such as the bearish divergences forming on the MACD. The technicals are bullish, but caution is warranted.

Correlation

Monthly Expected Return

Quarterly Expected Return

Monthly Standard Deviation

0.94

1.4%

4.2%

6.85%

P/B (Optimistic)

P/E (Optimistic)

P/B (Base case)

P/E (Base case)

P/B (Pessimistic)

P/E (Pessimistic)

$147.66

$98.17

$98.44

$87.26

$49.22

$76.36

The base case scenarios suggest QCOM is undervalued. Based on the fundamentals, the models suggest the shares are undervalued by 16.8%. This is a valuation conclusion that makes sense as the financial performance provides a tailwind to share price appreciation. Also, the share repurchase program doesn't hurt the bullish cause.

Source: Why I'm Still Bullish On Qualcomm