Buy Qualcomm On The Dips And Ride The Mobile Wave

Aug.25.14 | About: Qualcomm Inc. (QCOM)

Summary

Qualcomm has recovered a bit from an 11% drop since its earnings report but there is much more room to rise as the future is still very bright for the company.

The chipset technology segment has hit record highs and shows that Qualcomm is still a market leader in this space though Intel is gaining traction.

China under-reporting issues will hurt the licensing division in the short term but long run should rise and catch up with chipsets which could set up for a strong 2015 run.

"The market is a very sensitive beast that can turn in an instant on the slightest bad news. Sometimes this creates buying opportunities for the ones who pay attention." - Anonymous

Qualcomm (NASDAQ:QCOM) reported third quarter earnings with some really strong results. Due to the strength in the chipset technology segment, Qualcomm saw good increases in revenue and earnings year-over-year. These results resulted in an 11% drop in share price over the next few days. The culprit was the two words every investor dreads: lower guidance. Whenever a company forecasts lowered guidance, people rush to dump the stock without taking into account where the weakness is coming from and if it's a fundamental development or short-term event that will run its course.

So what caused this downward forecast? The lowered guidance came mainly from one source: China. Specifically the under-reporting from licensees in China. Below is an excerpt from the quarterly report.

"We also believe that certain licensees in China currently are not fully complying with their contractual obligations to report their sales of licensed products to us (which includes certain licensees underreporting a portion of their 3G/4G device sales and a dispute with a licensee) and that unlicensed companies may seek to delay execution of new licenses while the NDRC investigation is ongoing. We expect calendar year 2014 3G/4G device shipments to be approximately 1.3 billion globally. However, our estimate of calendar year 2014 3G/4G device shipments that we currently expect to be reported to us is approximately 1.04 billion to 1.13 billion, which is adjusted for units that we believe may not be reported to us, are in dispute or are currently unlicensed. We are taking steps to address these issues, although the timing of any resolution is uncertain." - 3rd Quarter Earnings Release

The impact of this caused Qualcomm to go from its 52-week high close of $81.60/share to as low as $72.49/share, down 11%. The issues in China are concerning and China represents a very large portion of international revenue for Qualcomm. Management seems to be confident in a resolution but have no firm timetable for a conclusion. Short-term uncertainty will put pressure on Qualcomm stock as these issues hang on but if a solution can be solved, the licensing segment could have blockbuster results as it catches up to the chipset division.

Speaking about chipsets, Qualcomm sold more chipsets than ever before which has helped push revenues to new heights. Table 1 shows the revenue derived from each segment in dollars and percentage of total revenue.

Table 1 - Qualcomm revenue derived from its segments

Year

Total Revenue

Chipset Technology

Technology Licensing

Wireless & Internet

2014

26,300 - 27,200*

69.8%**

29.2%**

0.7%**

2013

24,866

16,715 (67%)

7,554 (30%)

613 (2%)

2012

19,121

12,141 (63%)

6,327 (33%)

633 (3%)

2011

14,957

8,859 (59%)

5,422 (36%)

656 (4%)

2010

10,982

6,695 (61%)

3,659 (33%)

628 (6%)

2009

10,387

6,135 (59%)

3,605 (35%)

641 (6%)

* Guidance from Qualcomm for the 2014 fiscal year

** The percentage of each segment for the first 9 months of the 2014 fiscal year

Click to enlarge

One interesting phenomenon is the fraction of the total revenue derived from chipsets has increased steadily over the past few years. More and more of the revenue has been earned from the chipset technology segment with almost 70% of total revenue so far in 2014. As a market leader in the mobile industry, Qualcomm continues to gain a stranglehold on the top position and these results show this is not slowing down anytime soon.

China poses an issue for Qualcomm in the short term but the Chinese market is something that cannot be ignored and it is because of two percentages: 42% and 78%.

Chinese Internet Market Explosion

If you follow our stock portfolio, there is one constant message. The inevitable rise in internet adoption in China. Currently, developed countries such as the United States, Germany, France and Canada all have ~80% of the population using the internet. China currently has 42% internet adoption. This number will not last long though as there has been a steady rise in that number and it won't end anytime soon. At 42% of a population of 1.35 billion people, this translates to ~570 million internet users. That is almost double the population of the entire United States of America. Such a market cannot be ignored for technology companies. A previous post looked at this huge market and the impact on Chinese internet companies such as Baidu and Qihoo 360 but this also benefits Qualcomm.

The big appeal to Qualcomm though is that mobile is the more popular medium for accessing the internet in China. The main medium for accessing the internet in China with 78.5% of the population is through mobile. If you project to 2020 that 78% of the population adopts the internet with 80% through mobile, even with a stagnant population of 1.35 billion people, the mobile market is over 842 million people. The underreporting issue is a headache for Qualcomm but a headache that could pay off handsomely in the future if and when it is solved.

How Qualcomm Compared to Competitors

Three competitors were isolated for Qualcomm with Intel being the biggest in terms of market cap. Table 2 shows some financial metrics around valuation and performance for Qualcomm and a few of its chief competitors.

Table 2 - Valuation and Performance Metrics for Qualcomm and Competitors

Parameter

Qualcomm

Intel

Broadcom

NVIDIA

Market Cap

$125.8B

$170.4B

$22.5B

$10.8B

P/E Ratio

16.9

17.0

34.1

20.8

P/S Ratio

4.75

3.14

2.73

2.41

P/B Ratio

3.22

2.86

2.59

2.55

Gross Margin

63.8

76.7

55.0

60.8

Net Profit Margin

28.8

19.1

7.9

12.0

Return on Assets

15.7

11.2

5.4

7.3

Return on Investment

19.5

14.2

6.4

9.0

Dividend Yield

2.3%

2.6%

1.3%

1.8%

Dividend Payout Ratio

30.1%

46.4%

59.5%

41.3%

Long-Term Debt/Equity

0.00

0.22

0.16

0.33

Click to enlarge

Qualcomm with its 11% drop in stock price actually has the lowest price-to-earnings ratio compared to its competitors with Intel comparatively low. The price-to-sales and price-to-book ratio comparisons though show that Qualcomm is priced higher than the rest. The reason for this is that Qualcomm has the best net profit margin over the past twelve months compared to the rest at 28.8%. The next highest net profit margin belongs to Intel at 19.1%. Both return on assets and return on investments for Qualcomm beat the field handily showing that Qualcomm being a market leader is not for nothing.

Qualcomm has been aggressive with stock buybacks and raising dividends though Intel has a higher dividend yield. Looking more deeply, the dividend payout ratio for Qualcomm is 16.3% less than Intel which means Qualcomm has more room to increase the dividends it pays out compared to Intel. With Qualcomm's background, there is a strong bet for an increase in dividends in the near future.

Last item looked at was the long-term debt for each company. Qualcomm currently on its balance sheet has no long-term debt. In fact, over the past four years Qualcomm has had no long-term debt on its balance sheet. Debt is not the only factor over whether to invest in a company or not but as anyone who has been in debt can attest to, there is much more financial freedom without long-term debt which gives Qualcomm another tick on the pro side.

Final Thoughts

Qualcomm took a hit and the fears of the stock market are real with respect to China. Short-term weakness is most likely expected but over the long haul Qualcomm should recover from this short-term underreporting issue. China is a mobile market that cannot be ignored and with Qualcomm producing as a market leader in mobile technology, the long-term prospects are bright. From the dip as low $72.49/share, the stock has bounced back to the mid $70/share range but I believe there is much more room to grow and today may provide an opportunity to scoop up some stock in a great company at below market price levels.

Another note worth looking at was the threat of Intel (NASDAQ:INTC). Intel is much larger that Qualcomm with a higher market cap and more importantly a much larger R&D budget. With a renewed focus on mobile, even though they are late in the game they could gain traction. Recent news of a deal to use Intel LTE technology for some of Samsung smartphones shows the future potential. Intel may be another company deserving of a look to invest in.

Disclosure: The author is long QCOM.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.