Qorvo Still Not Getting Its Due

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About: Qorvo, Inc. (QRVO), Includes: QCOM, SWKS
by: Stephen Simpson, CFA
Summary

Qorvo beat lowered expectations for the fiscal fourth quarter and raised expectations significantly for FQ1'20, but the full year's growth is still likely to be subdued.

Qorvo likely lost business at Apple back to Broadcom, but the company is winning more content with Korean and Chinese OEMs and should see Mobile growth in FY'21+.

Meanwhile, IDP continues to grow very well, with attractive longer-term opportunities in 5G, IoT, defense, and industrial/data center after the Active-Semi deal.

Qorvo looks undervalued below the high $80's, but has long frustrated investors with inconsistent performance in Mobile and gross margin.

When I last wrote about Qorvo (QRVO) in early January, I thought the shares of this chip company were undervalued, but I thought the near-term outlook was clouded by the possibility of another guidance cut (which happened with fiscal Q3 earnings in February) and a lingering perception of Qorvo as a “problem child” with respect to overreliance on mobile end-markets and problematic gross margins. To that latter point, the shares have continued to consistently lag the SOX since that last article, though they’re up about 20%.

Generating alpha by investing in laggards is a tough way to go, but it is not without its rewards. Once a company’s perception changes, the rerating can be quick and significant. While Qorvo seems to have lost content with Apple (AAPL) (back to Broadcom (AVGO), presumably), I think the IDP segment is under-appreciated, and I likewise think the gains with non-Apple vendors are underappreciated for their margin benefits. It doesn’t take heroic assumptions to get a high $80’s fair value, but this is a stock that has tested investor patience for some time and we may not be out of the woods yet with this sector correction.

Beating A Lowered Bar In The Fiscal Fourth Quarter

Qorvo’s March quarter wasn’t bad relative to the expectations going into the quarter, but it’s well worth remembering that those expectations were reset after the December quarter, so it’s not as though everything is going swimmingly.

Revenue rose more than 2% year over year, but declined 18% qoq, beating expectations by around 2%. Mobile revenue fell 2% yoy and 26% qoq, with underlying unit volumes being a significant negative contributor to the results. IDP once again did quite well, with 12% yoy and 3% qoq revenue growth and its 12th straight quarter of double-digit yoy revenue growth on strong 5G, but also good results in defense, auto, and IoT markets.

Gross margin improved 20bp year over year and fell 130bp qoq, beating expectations by 120bp. Operating income rose almost 3% yoy, but fell more than a third sequentially with 10bp of yoy margin expansion and almost seven points of sequential contraction.

All in all, in the broader context of what’s going on with handset suppliers and semiconductor end-markets in general, I’d call this a pretty good quarter. I’d also note that management guided FQ1 much higher, though the full-year guide was more moderate and backs up the idea that they’ve lost business with Apple.

One thing I didn’t like so much was the inventory information – inventory levels rose 8% yoy and 10% qoq and inventory days are still well above the median (111 vs. 85). This is a pretty common issue across the space, and I can see the argument for having inventory on hand to supply ramps in 5G, Chinese handsets, and so on, but it’s a risk factor all the same.

Mobile “Is What It Is”

Qorvo surprised a lot of people when they won some meaningful business with Apple in mid/high-band PAD. Broadcom vowed they’d get it back, and it looks like they have … and it stings a little more that Qorvo’s wins took place during a generation that didn’t sell particularly well. On the other hand, Qorvo has done well with other OEMs. The company has been gaining share with Samsung, and has likewise been increasing its content with Chinese OEMs like Huawei.

I don’t expect the situation to get a lot easier from here. Broadcom has made it clear that they are committed to the space, and Skyworks (SWKS) and Qualcomm (QCOM) are likewise ongoing threats, with Qualcomm trying to tie more front-end content into its 5G chip offerings. Still, those wins in Korea and China count for something, and after what I expect to be a slightly down year in FY 2020, I think Mobile will be a grower for Qorvo again in 2021 and beyond.

IDP Should Get More Attention

I’m not a big fan of sum-of-the-parts valuation, mostly because it assumes that the Street is more rational than I’ve found it to be. In any case, I have to think that if Qorvo’s IDP business were independent, it would trade with a pretty attractive valuation today.

In addition to the aforementioned 12 straight quarters of double-digit growth, this business is just getting started with opportunities in 5G (where it estimates around $1,200 of content with basestations), IoT (connectivity), and defense (where it just won a multiyear GaN contract with Lockheed Martin (LMT).

Management is also committed to helping this business grow. The acquisition of Active-Semi back in April doesn’t add much in the way of revenue (around $50 million estimated for this upcoming fiscal year), but it does bring high-performance analog and power management capabilities, expanding the company’s addressable markets in 5G, auto, and IoT (smart homes), while also adding end-markets like industrial and data center, and product categories like motor control modules and PMICs. Qorvo will have plenty of competition here (including Texas Instruments (TXN), Analog (ADI), and Maxim (MXIM) ), but it’s a logical expansion of the business into some attractive markets.

The Outlook

With the 5G ramp still in its early days, headwinds from the Apple business, and ongoing uncertainties about several chip end-markets, FY 2020 isn’t going to be a banner year for Qorvo, but then nobody expects it to be. I do expect acceleration, though, and I’m still looking for long-term revenue growth in the 7% to 8% range, with IDP driving a lot of that opportunity.

Qorvo’s progress on gross margin improvement has been rocky and inconsistent, but I do believe the situation is getting better. While the fab consolidation efforts announced last quarter will create some near-term pressure, it should help long term, and I think management is trying to find that difficult sweet spot between maximizing current margins without leaving themselves short of capacity should they score a big OEM win and/or end-markets re-accelerate faster than expected.

I believe that Qorvo will get to adjusted FCF margins of 20% and higher relatively soon, driving low double-digit long-term FCF growth.

The Bottom Line

Qorvo’s low gross margins are a headwind to one of my valuation approaches, but the shares look undervalued on discounted cash flow and adjusted op margin-driven EV/revenue. With what I believe to be realistic-to-conservative expectations, it’s not hard to argue for a fair value in the high $80’s, which still leaves meaningful upside for Qorvo – not a common occurrence in the chip sector today. I realize Qorvo has been a frustrating name for a long time, but with a strong IDP business and a potentially stabilizing then improving mobile business, I think this name is worth a look.

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.