Qorvo Still A Few Ducks Short Of A Nice Row

| About: Qorvo, Inc (QRVO)

Summary

Qorvo's mobile revenue will grow on the back of Intel's wins with Apple and greater share with Chinese OEMs, but rivals are looking to push them in filters.

Margins are now the chief worry, as gross margin has dropped below 50% and may stay there for a while.

If Qorvo can improve its margins, a mid-$60s fair value is reasonable, but today's price is pretty fair if margin leverage proves to be more limited.

For a chip company like Qorvo (NASDAQ:QRVO), there's an ongoing need to pair attractive revenue growth with strong margins as both loom large in chip stock valuation. Recently Qorvo has done well shoring up the prospects for the first half, as content wins with Apple (NASDAQ:AAPL) and ongoing share growth with Chinese handset makers are making a good case for mobile revenue growth. What's more, wireless infrastructure seems to be rebounding nicely off a recent bottom.

But Qorvo still doesn't have all of its ducks in a row. Gross margin has disappointed recently and management's guidance was not particularly encouraging - dredging up past margin concerns and limited the enthusiasm over share-driven revenue growth. Healthy margins can justify a fair value in the $60s today, but I don't consider management execution to be a given here like I do with Broadcom (NASDAQ:AVGO), and there are risks that rivals like Skyworks (NASDAQ:SWKS) and Qualcomm (NASDAQ:QCOM) will ultimately squeeze a little harder in the future.

Intel Helps

I mentioned in the last piece I wrote on Qorvo, the company stood to gain a lot from penetration of Intel (NASDAQ:INTC) chips in the Apple iPhone 7. While the extent of Intel adoption (if any) was still an open question then, it no longer is. On the other hand, teardowns have also indicated that Qorvo didn't register as much content growth as the bulls had hoped, with average content apparently up around 5% from the Apple iPhone 6S.

Still, I would call this a win on balance. Qorvo isn't benefiting as much from the iPhone 7 as either Avago or Skyworks in terms of content gains, but it still gives them better exposure to what is looking like a better opportunity given Samsung's (OTC:SSNLF) recent battery issues.

And So Does China

It's not just the Apple/Intel dynamic that's helping Qorvo. The company has a solid cost-effect product suite across all the bands (Avago focuses more on the high end), and that is helping the company win more business with Chinese handset OEMs. Huawei is a 10%-plus customer for the company, and Qorvo has also been increasing its share with OEMs that use MediaTek chips.

Mobile revenue was down year-over-year back in the April quarter, but improved to flat in the July quarter and should resume growth, as the mobile business showed improving momentum and management raised its revenue growth expectations. While the high-end smartphone market has definitely slowed, there is still an ongoing evolution toward more and more capable phones that require substantially more filter, switch and power amplifier content. There will be ongoing pricing pressure through this process, but Qorvo should still be a net beneficiary as LTE phones become more and more the global mainstream.

But Margins Don't

Sequential revenue growth of 15% in the last quarter and a guidance improvement suggesting a doubling of the sequential growth rate for the next quarter (from an expected 10% to a guided 20%) would normally be great news. Unfortunately, margins concerns have emerged once again as a real concern.

Qorvo has now delivered four straight sub-50% gross margin quarters, and management lowered expectations for the next quarter to 47% - a roughly one-point additional drop from the last reported quarter. Management blamed low manufacturing yields while ramping up multiplexers and a revenue mix skewed to lower-margin PADs, but the bigger issue is that none of this seems to be quickly fixable.

Instead, it sounds as though management will be using the upcoming November analyst day as a chance to outline its path back to 50%-plus gross margins. I would expect the company to talk more about its wafer changes (moving to 8-inch BAW wafers and 6-inch TC-SAW wafers), insourcing more test and assembly, and relocating production as important steps in the process. A fundamental concern will linger, though, that these margin pressures are inextricably linked with the company's higher skew toward Chinese OEMs (where cost is a driving factor).

And it may well be the case that these pressures are going to get worse. Skyworks seems to be getting more serious about its efforts in filters and Qualcomm has its joint venture with TDK for filters and front-end modules. Longer term, I just don't see Broadcom and Qorvo maintaining what has effectively been a duopoly, though I think Broadcom's focus on the high end will give it some cover. There has been talk lately that Qorvo has been closing some of that quality/performance gap with Broadcom, but I think that's likely more wishful thinking than reality at this point.

The Opportunity

To its credit, management has been continuing to try to build the non-mobile/handset business, with the April acquisition of GreenPeak Technologies adding ultra low-power, short-range RF communication tech to its arsenal (largely for IoT applications). While there are growth opportunities here like base stations, auto and IoT, realistically speaking, I don't think Qorvo's non-mobile business becomes a more meaningful contributor unless/until they make some larger deals to bring in more scale. Whether such deals would be good for shareholders depends almost entirely on what they buy and what they pay - the notion of diversification is fine, but an expensive or strategically dubious deal doesn't help just because it adds more revenue to a different bucket.

Qorvo has a strong position alongside Broadcom and Skyworks in several mobile component segments, including PA modules, switches and filters. OEMs like Apple and Samsung have a vested interest in seeing a relatively healthy supplier ecosystem; so there will always be some churn among sockets but likely always a spot at the trough for all three companies (and other suppliers like Murata) provided the price/performance attributes remain acceptable. Broadcom has helped itself a lot (in my opinion) by focusing on high-end capability, while Skyworks is now trying to become a more diversified supplier. I like Qorvo's ability to offer "good enough" at an attractive price and across a broad range of products, but I do have those concerns that companies like Skyworks and Qualcomm could pressure in the future.

The end result of my modeling assumptions is now a long-term revenue growth rate of around 7%; while that's down from my prior estimate it is only because we've moved out another year. My "like for like" number for what had been my Year 10 estimate is actually higher. On the margin/FCF side, I am concerned that it will take longer for Qorvo to get there on margin leverage, and I'm looking for a slower ramp and a slightly lower plateau. That still leads to a double-digit FCF growth expectation and a DCF-based fair value of $65, but it is worth repeating that Qorvo's margins have to improve from here for that to hold water. Looking at more short-term metrics, the near-term margin outlook would suggest that today's price is pretty fair in EV/revenue terms.

The Bottom Line

I'm not worried about Qorvo's ability to grow and I don't think the market really is either. Intel's success with Apple has given Qorvo a boost and the company continues to do well with Chinese OEMs. On the other hand, how profitable that growth will be is less certain, and that really is the key to Qorvo delivering more value in the future. I liked Qorvo back in March and the stock is up from there - outperforming Skyworks (and NASDAQ), with Broadcom more or less keeping pace. Further upside is there, but investors need to hold management's feet to the fire when it comes to delivering on margin improvement.

Disclosure: I am/we are long AVGO.

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.