- Qualcomm beats revenue and profit estimates for the second quarter. Therefore, COVID-19 does not necessarily lead to the end of the world.
- The launch of new 5G products has already contributed to growth in the QCT segment, underscoring the strong foundation that Qualcomm has built.
- Even if it still takes some time until the potential is realized, it is worthwhile at least to enjoy the dividend yield, which has meanwhile increased by 5 percent.
Qualcomm (NASDAQ:QCOM) exceeded its revenue target and profit estimates for the second quarter. With this, the tech company has delivered convincing figures, just like Alphabet (GOOGL) and Microsoft (MSFT) before and has shown that COVID-19 does not necessarily lead to the end of the world. Let's take a closer look at the numbers.
The second-quarter numbers have shown some light at the end of the COVID-19 tunnel
The QCT segment that includes Qualcomm's broad portfolio of CDMA- and OFDMA-based technologies, including wireless devices and infrastructure integrated circuits, saw growth on a three-month as well as on a six-month basis. Only a little but not an important licensing business saw a small decline in the second quarter.
(Source: Latest filing)
Much more important is the licensing business in the QTL segment (do not confuse both). According to the company, QTL:
grants licenses or rights to use portions of our intellectual property portfolio that are essential to the manufacture and sale of certain wireless products. Providing access to our leading intellectual property portfolio for wireless technology has been a catalyst for industry growth".
The QTL business shrank by USD 50 million in the second quarter but met the midpoint of the company's guidance.
(Source: Latest filing)
The main reason for the decline in revenue was COVID-19 (what else?). I do not see the substance of the business threatened, however. You can see from the earnings call that demand in China increased sharply again at the end of the second quarter, which is excellent news.
First, pronounced weakness in China in late January and February, followed by a substantial recovery exiting the quarter. And second a decline in demand in many other regions globally starting in March. This negative impact on QTL was partially offset by a benefit related to updates to previous royalty estimates and favorable mix.
I think that demand will also increase again in the rest of the world. Investors must bear in mind that China, in some cases, has a lead of more than two months over Europe and especially America. COVID-19 is like a wave that slowly spills over the earth. The effects will continue to be felt for a long time to come, but the figures from China show that Qualcomm will not be among the companies that suffer the most (unlike tour operators or airlines).
As expected, the QSI segment performed poorly. The QSI segment contains "strategic investments, many of which are in early-stage companies, that open new, or expand upon, opportunities for our technologies in voice and data communications, as well as new industry segments."
(Source: Latest filing)
Investors should note that Qualcomm has managed to keep EBT margins stable in both the key segments QCT and QTL. Here too, the company was able to meet its forecast despite the difficult circumstances. On a six-month basis, the QTL business even had an EBT margin of almost 70 percent, which underlines how important the licensing business is for the company's profit. Nevertheless, the company is still some way off achieving its old figures.
(Source: 2019 results/table by author)
I also consider it unlikely that the company will reach these figures again soon, as antitrust regulations probably limit the maximum exploitation of possible pricing leeway. Nevertheless, margins should remain stable in the future. According to the expectations of FactSet, the net margin, as well as the operating margin, could even increase.
(Source: Dividend-screener Dividends.stocks.cash)
Assessing the possible near-term upside potential
Currently, the company seems to be traded below its fair value P/E ratio. With a fair value P/E ratio of 27 based on 10 years P/E ratio, the stock price should be around USD 100. With an actual price of about USD 80, this indicates an upside potential of more than 20 percent.
However, this is based on an expected EPS of USD 3.8. With an assumption of approximately 30 percent reduction in handset shipments, Qualcomm expects revenues of USD 4.4 billion to USD 5.2 billion and non-GAAP earnings per share between USD 0.60 and USD 0.80 for the third quarter. If you scale this up to the full year, it will be difficult for the company to achieve EPS of USD 3.8. Under normal circumstances, however, this EPS would have been achievable because the guidance already includes a greater than USD 0.30 adverse impact due to the reduction in handset shipments.
Market trades post COVID-19
But I am confident that Qualcomm will achieve these figures in the medium-to-long term because fundamentally, the company is very well positioned. I have taken an in-depth position on this in past analyses. I consider two markets to be particularly relevant, all of which are related to the launch of 5G:
Now that Intel has left the market for 5G modems for smartphones, Qualcomm is more or less without competition. This applies above all to the USA and Europe, where Asian competitors such as Huawei have a difficult position for political reasons.
Qualcomm is also turning its attention to other emerging markets that will experience extreme growth, particularly with the introduction of 5G. This concerns in particular "Autonomous driving" and "V2X"
There are already signs that Qualcomm will succeed here. The success refers to both essential business areas, the QCT, and the QTL segment. The earnings call was very illuminating in this respect:
In our licensing business, we have now signed more than 85 5G license agreements, up from 80 license agreements last quarter. As expected, we recently entered into new long-term global patent license agreements with two leading Chinese handset suppliers OPPO and Vivo to cover 5G multi-mode mobile devices.
As we look to the second half of calendar 2020, while there are a few regions with minor delays in 5G network deployments. Overall, 5G is progressing as planned and we continue to be well positioned to drive the rapid adoption of 5G globally.
To that extent, the launch of new 5G products has already contributed to growth in the QCT segment, underscoring the strong foundation that Qualcomm has built.
QCT revenues and EBT increased by 13% and 39% sequentially. This reflects the benefit of the first wave of 5G flagship launches, increased content from our RF front end chipset solutions and improved gross margins. In addition, we saw strength in our IoT and networking products due to increased demand for connectivity in this work-from-home environment.
Sooner or later, the market will take this potential into account and price it in. At that point, Qualcomm will be trading above USD 100. In this respect, COVID-19 could even give a boost in the long term, as countries recognize how important digital networking and especially IoT can be in the future.
I still see Qualcomm as a buy. After my last buy recommendation in March, the share price has moved almost identically to the market. But in the medium to long term, I see the potential for Qualcomm to outperform the market. So, now it is still an excellent time to jump on the train. Even if it takes some time until the potential is realized, it is worthwhile at least to enjoy the dividend yield, which has meanwhile increased by 5 percent and is now over 3 percent.
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Analyst’s Disclosure: I am/we are long QCOM. 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.
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