'Strong Buy' For Qualcomm Given Chinese Demand

| About: Qualcomm Inc. (QCOM)

With the stock up by almost 40% since 2008, Qualcomm (NASDAQ:QCOM) is well positioned to accelerate value creation. This designer and marketer of digital wireless technology products and services is experiencing tremendous growth in emerging markets as it shifts to 3G. At the same time, tier-1 Asian OEMs continue to penetrate the market and grow opportunities. An improving handset and tablet market is laying, in my view, the foundation for a technological renaissance that will greatly benefit Qualcomm.

On the third quarter earnings call, CEO Paul Jacobs noted:

The migration from 2G to 3G continues as well, with Wireless Intelligence reporting that at the end of June, there were approximately 1.4 billion 3G subscriptions globally, up approximately 30% from a year ago. And Wireless Intelligence predicts that by the fourth quarter of this year, 3G will be contributing greater than 50% of net subscriber addition.

Driven by the increased demand for 3G and data-capable devices, wireless data traffic continues to accelerate. Operators continue to make network investments in the latest radio technologies for both existing and new spectrum. According to the GSA, the number of operators that have commercially launched HSPA+ now totals 136. 39 of these operators have commercially launched Dual-Carrier HSPA+, a 70% increase in the last 3 months. Additionally, there are now 218 operators that are investing in LTE, including 24 networks which have commercially launched.

While these developments are moving the company into more costly areas and hence, I model gross margins declining from 70.3% currently to 66.9% in 2013, they are sustainably driving top-line growth. 3G subscribers in China increased by roughly 3 times y-o-y to 94M and demand remains very strong. CDMA trends are healthy and Qualcomm is benefiting from its ability to support many operating systems as mobile and computing increasingly converge.

Additionally, strong product launches by other companies are a catalyst that saves in-house R&D costs. Accordingly, I forecast R&D and SG&A declining by around 300 basis points to 16.6% and 130 basis points to 9.8%, respectively. Samsung (OTC:SSNLF)Galaxy S II, Win 8-WP7, Android, ZTE, and Huawei are establishing further inroads in emerging markets.

In particular, I foresee gains from Samsung, LG, and Motorola (NYSE:MMI), offset slightly by Sony (NYSE:SNE) and HTC challenges. From a risk/reward standpoint, these trends make Qualcomm a safer investment than most other domestic companies given concerns over a double dip. In 56 key cities, China Unicom released 21 megabit per second HSPA+ services, strengthening the international foundation that Qualcomm will grow off of in the following years.

Although I wrote a relatively bearish report for Apple's (NASDAQ:AAPL) long-term prospects, demand is likely to remain strong in the short-term and will benefit Qualcomm's growth opportunities. The wireless communication provider recently made a 28-nanometer upgrade, showing signs of contined innovation that will make it a market leader. By June's end, subscriptions rose by an impressive 30% from last year and smartphone sales exceeded 100M in the first quarter of 2011 growing by 85% y-o-y.

Overall, I find myself in agreement with the currently "strong buy" rating of Wall Street analysts. Consensus estimates for EPS are that it will grow by 29.7% to $3.19 in 2011 and then by roughly an average of 10% in the next two years. I model revenue growing by 34.7% to $14.8B and then by 14.3% in the following year driven largely by OEM gains and a flourishing global market.

For those looking for exposure to the international market, Qualcomm provides an attractive solution. With a dividend yield of 1.56% and the stock trading at 15.8x forward earnings, the company provides favorable risk/reward. A forward PE ratio of 15.8 may not suggest the tech company is undervalued on a multiples basis, however, given the strong indicators of demand improvement amidst macro stagnation, Qualcomm is well positioned to benefit from recovering economies.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.