According to IHS Technology, the global market for connected devices that allow users to access the internet is set to surpass 6 billion units this year as new products including cellphones, tablets, and computers enter the electronics ecosystem. With that level of market expansion Qualcomm will enjoy more earnings in the future.
Qualcomm, Inc. (NASDAQ:QCOM) introduced the new technology as "MU-MIMO," which stands for "multi-user, multiple-input, and multiple-output." This new technology allows networks to transmit data to multiple groups of users simultaneously using algorithms that adapt on the fly to changes in usage. Qualcomm said MU-MIMO could triple Wi-Fi speeds in homes, offices, and on public networks. Qualcomm plans to sell MU-MIMO-enabled chips to manufacturers of wireless routers and access points and to companies that make smartphones, tablets, and other consumer electronics. It plans to start demonstrating the technology in the next few months before beginning shipments to customers in early 2015. With both the network and its users employing MU-MIMO Qualcomm claims it will boost speeds by two to three times. Presently the Wi-Fi networks can only serve one device at a time, cycling quickly among different users. That creates slower speeds for everyone when more devices connect to the network.
Qualcomm's Crawling Growth For the First Quarter
Qualcomm released earnings for the second quarter of fiscal year 2014. The earnings increased for the quarter but at a rather slow pace. This was the smallest year-over-year percentage increase since the June quarter of 2010. A number of factors were behind the low growth rate. In the second quarter, Qualcomm generated $6.37 billion in revenues reflecting a year-over year increase of 4%. The revenue then fell 4% by the next quarter because the company could not manage to match the previous quarter's 10% revenue growth. The second quarter's revenue growth was derived from the MSM chip shipment of 188 million units or 9% year-over-year increase.
The earnings growth in the second quarter was better than the revenue growth. On a GAAP basis, the operating income of $1.99 increased 6% year-over-year and 33% sequentially. The solid demand for multimode 3G/LTE chipset solution and improved licensing revenues helped the net income reach $1.99 billion with a 5% growth rate year-over-year and 4% sequentially. Due to the strong net income the GAAP diluted earnings per share of $1.14 improved by 8% year-over-year and 5% sequentially. Lower than expected growth in China was also one of the reasons behind the fall in Qualcomm's profits; however, the situation is likely to change soon with the introduction of 4G LTE connectivity in China.
Despite the slow growth, Qualcomm is confident after releasing its second quarter results and the company has raised its earnings outlook for fiscal year 2014. Supported by the increasing demand for its chipsets and strong growth of 3G/4G smartphones around the world, Qualcomm revised its previous earnings expectation of $5.00-$5.20 and now expects earnings per share in the range of $5.05 and $5.25 with a growth rate of 12% to 16% for full fiscal year 2014.
Qualcomm is Not Alone
Qualcomm is not alone with regards to the slow growth problem in the smartphones chips market. ARM Holdings (NASDAQ:ARMH), the chips architecture giant, also suffered slow sales growth due to the drop in high-end smartphones sales during the first quarter of 2014. In the fourth quarter of 2013, ARM's revenue increased 15% compared to the same quarter of the previous year and revenue growth slowed down to 10% in the first quarter of 2014. Similarly, its EPS increased 30% in the fourth quarter of 2013 and the EPS growth rate declined to 5% in the recent first quarter of 2014.
Another important factor to consider when talking about the smartphones chips industry growth is the market shift from developed countries towards developing countries. With the expansion in the smartphones industry moving away from wealthy markets like the U.S. and towards China, India and other markets where consumers favor mid-range devices instead of high-end devices Qualcomm's growth is likely to get hurt to some extent.
Sooner Or Later, Qualcomm Will Enjoy Growth from 4G LTE in China
Qualcomm expects improvements later in fiscal year 2014 as China Mobile (NYSE:CHL), the world's largest cellphone carrier, rolls out its new 4G network. China and other developing countries are a major opportunity for Qualcomm as consumers upgrade from feature phones to smartphones and as China Mobile rolls out its 4G network with technology from Qualcomm.
While a majority of Qualcomm's revenues come from selling baseband chips that enable phones to communicate with the carrier networks most of its profits comes from the licensing of patents from its widespread CDMA cellphone technology. China Mobile's user base is around 781 million with less than 20% 3G penetration. The adaptation of 4G LTE by 100 million users by the end of this year means Qualcomm's earnings will increase at a fast pace later this year. Also, according to the latest media report, China's telecoms regulator is considering awarding 4G licenses for the FDD-LTE standard as soon as next month to China Telecom (NYSE:CHA) and China Unicom (NYSE:CHU). With the LTE enabled chipsets and increasing 4G LTE adaptation, Qualcomm is likely to remain at the top and earn more revenue growth. Qualcomm has developed a chip that is compatible with China Mobile's proprietary TD-SCDMA technology giving it a leg-up to ride this growth trend. Only 29% of China's market owns a smartphone, suggesting great potential upside over time.
Qualcomm Is Maintaining its Competitive Position
Qualcomm has released two new high-end chips, the Snapdragon 808 and Snapdragon 810 and both of these chipsets will be available at the beginning of 2015. These chips are Qualcomm's seventh and eighth high-end chipsets over the last few months. Qualcomm launched the 64-bit Snapdragon 410 in December quickly followed by Snapdragon 602A in January and the Snapdragon 610, 615, 801 and 805 in February. Qualcomm has adapted this strategy to beat Media Tek and Intel (NASDAQ:INTC) in the 64-bit chipsets segment. The better than expected demand for 64-bit chips would also support Qualcomm's need to boost its recently slow earnings growth.
The recent quarter was a temporary phase that reflected slower growth and the lack of new high-end devices also adversely impacted the chip-maker. However, these market conditions are likely to reverse soon because of the 4G LTE adaptation in China and other developing countries. Qualcomm's hard push to dominate the 64-bit chipset market will also support the company's growth because the market conditions are turning favorable for 64-bit chipset based smartphones and tablets. Apart from that, the slowdown in smartphone and tablet shipments may remain a concern but growth will come from the emerging markets. Even if the growth isn't a lot it will be good enough for Qualcomm to remain at the top.
Over the last twelve months, Qualcomm's stock has increased 24.7%, outperforming the S&P 500 that went up 18.5% over the same period. The stock is trading at a favorable P/E ratio of 22.1X which is cheaper than the industry average P/E ratio of 35.5X and also lower than Qualcomm's past five-year average P/E ratio of 23.7X. The stock seems to be even cheaper at a forward P/E ratio of 13.65% with 27.8% EPS growth for this year. For this stock the average target price is $85.04 and it translates into an upside potential of around 10% to its current price.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by a Gemstone Equity Research research analyst. Gemstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Gemstone Equity Research has no business relationship with any company whose stock is mentioned in this article.