Qualcomm: Still On The Path

Summary

• Qualcomm remains on a path to a $7 EPS despite smartphone market weakness.
• The company still has substantial share repurchases to complete.
• The license royalty deals with Apple and Huawei remain the biggest risk to the EPS targets.
• The stock is a bargain at $52 with a 4.8% dividend yield.

As FY19 progresses, Qualcomm (NASDAQ:QCOM) remains officially far off from its targeted EPS of $7. General smartphone market weakness has hidden the progress the wireless semiconductor company has made in support of my bullish investment thesis. A shift to 5G in 2019 should reverse the negative trend in a positive way for the stock. The company remains on a path to the $7 EPS target.

Image Source: Qualcomm website

Smartphone Weakness

Qualcomm trades just above $50 due revenue weakness and March quarter guidance for only earning $0.70 when the company was predicting an annualized rate of $7 per share. The loss of the Apple (AAPL) modem business and general smartphone market weakness isn't helping short-term results.

A lot of the end of 2018 smartphone weakness appears centered around the trade wars and possibly some replacement cycle lengthening due to 5G devices on the horizon. According to IDC estimates, the smartphone market fell 4.9% YoY in Q4.

So Qualcomm missing revenue targets wasn't exactly a company issue. The company sells less chips and collects fewer royalties when device shipments are weak.

According to CFO George Davies on the earnings call, Qualcomm had to lower expectations for FY19 based on the weakness generally felt from emerging markets and China:

Relative to our previous expectations, which had excluded any revenue from the interim agreement licensing revenues were lower by a $150 million to $200 million in the quarter. Given the headwinds facing the market broadly, we have reduced our global 3G, 4G device forecasts for the calendar year '18 to the low-end of our previous guidance range consistent with lower royalty units in the December quarter. Emerging regions and China were responsible for the largest shortfall in units relative to expectations although the lower levels of demand appear to be fairly widespread.

The company still guided 2019 device shipments to 5% growth, causing some consternation among analysts. The forecasts include 1% handset growth and what amounts to 27% growth for non-handset devices such as IoTs.

Source: Qualcomm FQ1 '19 presentation

Of course, the biggest problem with Qualcomm is that key customers like Apple and Huawei aren't fully paying royalties on smartphone sales. The company isn't fully benefiting on a device market that's still forecast to grow up to 5% this year, though down 50 million units at the midpoint from the previous guidance of 1.95 billion units.

Path To $7 EPS

As FY19 progresses, Qualcomm clearly isn't on a path to achieve the official $7 EPS target used to fend off the Broadcom (AVGO) bid. For several reasons, the company isn't going to reach the target this year, that's out of their control.

Source: Qualcomm FQ2 '18 presentation

Analysts have the company only on a path to hit $4.69 in FY20, so clearly a big disconnect exists. Primarily due to this reason, the stock is still stuck around $50.

Data by YCharts

Qualcomm management established three areas that would provide an EPS boost from FY18 levels of $3.69: Stock buybacks, cost reductions and license deals.

Stock Buybacks

A big part of the plan for an EPS boost was either the completion of the NXP Semiconductor (NXPI) merger or a large share buyback. With China never approving the deal, Qualcomm quickly announced a $30 billion stock buyback plan that the company already aggressively implemented with the original intent of providing EPS accretion of $1.25.

As of Dec. 30, the wireless semiconductor giant had executed $22.2 billion in share repurchases. The majority of the buybacks were via Accelerated Stock Repurchases that were only 40% completed as of Jan. 30. Otherwise, all of the shares haven't been repurchased under the ASR and another $7.8 billion remains under the authorization.

Per the earnings call, Qualcomm has spent an average price of $61 per share with the ASR. In FQ1, the average share count dropped ~200 million shares from 1.429 billion shares as of the end of the September quarter (FQ4 '18).

Data by YCharts

A fully implemented $30 billion share buyback at an average price of $60 would reduce the share count by 500 million shares. With the stock at $52 right now, the potential exists to reduce the shares by a greater amount for a bigger EPS boost.

Cost Reductions

A smaller part of the target of reaching a $7 EPS was reducing operating costs by $1.0 billion annually. The company forecasts being on a path to reduce costs by $1.0 billion to $6.4 billion annually, having already achieved $850 million in cost savings.

Due to some higher litigation costs, Qualcomm won't completely achieve that target in FY19, but the company is on track to reach the goal. Once the share reduction is completely implemented, the diluted share count will drop below 1 billion shares. Based on the cost reduction target and the effective tax rate, the EPS boost should equate to ~$1.

License Deals

The biggest unknown remains the unsolved license deals with Apple and Huawei. Qualcomm provided an EPS estimate of $1.50 to $2.25 per year for solving this part of the plan. According to IDC, these two companies are the second and third largest smartphone companies in the world accounting for ~33% of the global shipments.

The company remains in litigation with Apple as well as the FTC regarding whether Qualcomm exerts monopoly powers over the royalties charged on patents for the wireless sector. An adverse ruling in this case would have a negative impact on these estimates.

The company has an interim deal with Huawei that includes $150 million in quarterly payments. The deal only accounts for a partial payment of what Qualcomm estimated as due for a business doing close to $1 billion in quarterly licensing revenues. Another $1.5 billion in annual licensing revenues would easily add $1.50 to annual EPS estimates at the lower share counts.

Takeaway

The key investor takeaway is that Qualcomm remains on the path to generating a substantially higher EPS whether or not the $7 EPS target is achieved due to smartphone market weakness. The stock remains a bargain around $50 despite the FTC risk.

Disclaimer: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.

Disclosure: I am/we are long QCOM, AAPL, NXPI. 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.