Seeking Alpha
Long/short equity, research analyst
Profile| Send Message|
( followers)  

Qualcomm (QCOM) shares plummeted ~17% from its 52-week high of ~$68 in April primarily driven by the overall market weakness. My relative and absolute valuation models show that QCOM is undervalued at the current price level. Since the mobile chip industry tailwind such as migration from PCs to mobile devices remains intact and there has been no significant change in QCOM's operations, investors should consider gradually building up position for the company shares.

In this article, I will run you through both comparable company and DCF analysis to determine the fair value for QCOM.

Relative Valuation

I have picked Intel (INTC), Texas Instruments (TXN), and Broadcom (BRCM) as QCOM's industry peers in the comparable company analysis. They are major global players in the semi-conductor sector with market capitalizations above ~$10B.

Firstly, let's look at the group's historical revenue and EPS growth:

BRCM is the best performer in terms of 4-year revenue and EPS compounded annual growth rates (CAGR). QCOM's 4-year revenue CAGR is only slower to BRCM, but its 4-year EPS CAGR is mediocre at single digits. TXN has almost no growth in revenue and EPS over the past 5 years.

Then let's look at Street analysts' consensus estimates for revenue and EPS growth in the next 2 fiscal years:

I would rank QCOM first in terms of growth prospect as both its revenue and EPS are expected to experience 2-year CAGRs in the ~20% range - very balanced growth. Although BRCM is expected to grow bottom line by a 2-year CAGR of ~39%, its top line will likely grow at only ~10.7%. Compared to QCOM, INTC is expected to have much less growth momentum. TXN, however, will likely demonstrate decent bottom growth compared to its historical record.

Lastly, let's look at different historical profitability and liquidity metrics:

QCOM is the most profitable among the group in terms of 5-year EBIT and net margins. It also did the best in generating ample free cash flow. Its ROE is comparable to the group's average. Although BRCM demonstrates significant growth potential, it is the least profitable firm in the group.

Overall, I believe a valuation premium for QCOM should be warranted given its balanced growth prospect, substantial profitability, and strong cash flow generating ability. Then I performed the following valuation:

The fair stock value is calculated by equally weighting the trailing EBITDA and earnings multiple methodologies. To reflect QCOM's outperformance relative to the group and also the ample economic moat generated by its extensive CDMA patents, I assigned a 30% premium on each of the 2 price multiples. By multiplying the most recent financial metrics by their respective adjusted multiples, I arrived at 2 different valuations, which are equally weighted. Finally, the model yields a stock value of ~$61, representing a ~6.4% upside from the current price level.

Absolute Valuation

I also performed a DCF valuation with the following conservative assumptions:

(click to enlarge)

The assumptions incorporate the Street's consensus estimates and they yield a stock value of ~$66, a ~15% upside.

Based on both relative and absolute valuations, QCOM's current price level appears to be undervalued by ~10%. QCOM remains the best company to benefit from the secular trend of mobile device migration given its significant profits and free cash flow generating ability. Although facing stiff competition, QCOM's cash position and healthy balance sheet provides ample resources to invest in R&D and continue driving innovations.

Its CDMA patent portfolio helps enhance the stock's margin of safety as royalty revenue is relatively stable and predictable. In addition, there is also a foreseeable near term catalyst for the stock's upside potential, such as the release of Windows 8 which provides seamless integration between PCs and mobile devices. For all those reasons, I recommend a strong buy.

Charts and exhibits are created by the author. Financial data is sourced from company 10-Q, 10-K, press release, Yahoo Finance, YCharts, Wall Street Journal, Thomson One and Morningstar.

Source: Qualcomm Should Be A Buy At Current Price Levels