- QCOM is down 14% YTD, while the Nasdaq 100 is flat.
- Q2 earnings were solid but not noteworthy.
- 5G and WiFi 6E will be the medium and long term drivers for QCOM.
- Current dividend yield of 3.44% may be attractive to investors.
Qualcomm Inc. (NASDAQ:QCOM) stock has been hit hard by the coronavirus pandemic. The stock is down 14% YTD, versus the Nasdaq 100 Index that's flat for the year. Since I don't expect QCOM will be affected by the pandemic or the upcoming recession more than the average company, and considering that they still have potential for growth in the long term, I believe this is a great opportunity to buy the company at a discount.
Last week, Qualcomm announced their FY 2020 Q2 results. QCT, their semiconductor segment, reported revenues of $4.1B (+10% YoY) and EBT of $667M (+23%), but had a decrease in the number of MSM units sold (129M, -17%). Meanwhile their licensing business, QTL, reported revenues of $1.07B (-4% YoY) and EBT of $671M.
According to management, their results were negatively affected by a 21% YoY reduction in the demand for 3G/4G/5G handsets, due to the coronavirus pandemic. However, the pandemic also highlighted the importance of broadband in facilitating remote work, entertainment, education, telemedicine, and others.
For their QTL segments, the company reported they have now 85 5G license agreements, up 5 from last quarter. Of note are their long-term deals with OPPO and Vivo to cover 5G multi-mode mobile devices. They are still in discussions with Huawei, and the result of these discussions will surely have an impact on QCOM's stock price.
Many semiconductor companies reported steady demand in Q1/Q2 due to inventory accumulation from OEM's in case of a future disruption of supply chains. One analyst asked if this was the case too with Qualcomm, and the answer was very positive:
Well, I mean, we obviously spend a lot of time looking at the sell-in of chipsets versus the device sales and matching them and getting a sense of how the inventory profile is shaping out in China. Typically, you would see a decline in inventory following Chinese New Year in the March quarter. And we've actually seen it play out consistent with our expectations and there's been a slight decline in inventory through the process. - Akash Palkhiwala, CFO
Seeing a 21% drop in demand while clients stockpiled inventories would have been extremely negative, since the actual drop in end-demand would have been even greater. So despite the drop in demand, the news is not as negative as it could have been.
Lessons from China and Guidance
Using their experience with the Chinese shut-down, which caused a decrease of 21% of handset shipments, management forecasts a similar situation for Q3 around the world. The company is planning for a reduction of approximately 30% in handset shipments, resulting in the following guidance :revenues of $4.4-5.2B, EPS of $0.60-0.80, and MSM shipments of 125-145M. However, the company expects a rebound for Q4 as the worst of the pandemic passes.
With regards to 5G, in the month of March in China, 30% of devices sold were 5G devices, up from 19% in December 2019. On top of that, 71% of all launched models are 5G. This shows that the adoption of 5G continues at an accelerated pace. Management also stated they have not changed their 2020 5G smartphone forecast.
However, there were also some negative news from China in March. In the first trimester of the year, Huawei's HiSilicon unit overtook Qualcomm as China's number one chip supplier for the first time. HiSilicon shipped 22.21 million smartphone processors, increasing their market share from 24.3% in Q1 2019 to 43.9% the past quarter. This was in great part due to Huawei's increasing focus on the Chinese market since they were placed on the U.S. blacklist last year, which reduced some of Qualcomm's key customers' market share.
5G and Long Term Outlook
A big part of Qualcomm's future upside comes from the development and expansion of 5G. According to Qualcomm, 5G could deliver average data rates of over 100 Mbps, and peak rates of up to 20 Gbps. 5G is also designed to support a 100x increase in traffic capacity and network efficiency, and can also lower latency by 10 times, to 1ms.
However, all of that won't happen in day one. Wireless carriers will build their networks over time, and they won't be able to offer mm wave speeds right off the bat to everyone. If you wish to see demonstrations of the power of 5G, Marques Brownlee tried Verizon's and T-Mobile's 5G networks. In the Verizon video he used a Samsung phone equipped with a Snapdragon 855, and in the T-Mobile video a Snapdragon 855 Plus.
He got great but very different results in each test. In the T-Mobile test, he regularly got 40-140Mbps speeds, a 20-50% improvement over 4G. In the Verizon test however, he regularly got 600-1200Mbps, and even managed to get 2.1Gbps on one occasion. The big difference in the tests came from the fact that T-Mobile used Low-Band 5G (under 1Ghz frequency), while Verizon used mm wave. Nonetheless, there were some drawbacks with Verizon's mm wave. The range of the 5G network was incredibly small, and having any objects between the phone and the node interrupted the signal. In the below chart we can see the average speeds of 5G networks from different carriers.
Source:What Is 5G?
It's clear that 5G will be exponentially better than 4G, but it won't happen right away. It will take a few years before US carriers can offer mm wave 5G across the country. A similar thing will happen in other advanced economies, and emerging economies will probably have to wait even longer before the investments in infrastructure are made to provide a wide range of 5G coverage. That's why, even though I am very high on the upside 5G represents for Qualcomm, I believe we'll have to wait past 2021 to see a great impact.
Possibilities for 5G
5G won't just be an improvement over 4G. It will open up countless possibilities and will have a huge impact. For example:
- Less need for onboard storage:With extremely fast speeds and low latency, having a large onboard storage in phones and other pieces of hardware won't be as important, since cloud storage could be extremely quick and accessible. OnePlus CEO agrees with this thought, stating that super-fast cloud access could make onboard storage obsolete.
- Gaming could also be affected. Qualcomm president said that 5G game streaming could stop the need to update gaming consoles, since there will be unlimited processing capability at the edge.
- Future generations of driverless cars could leverage 5G to interact with other cars and even smart roads, to improve safety and traffic. Without the low latencies of 5G, this would be impossible. 5G would allow a constant and extremely fast exchange of information between cars, allowing them to be more aware of their surroundings and make timely decisions. In fact, Qualcomm already has their first generation Snapdragon Automotive 5G Platform.
- 5G home internet could be a more widely available and cost-effective solution than equipping each house with fiber optic lines. With Qualcomm's modem-to-antenna solutions, carriers can use their 5G antennas to provide homes with internet speeds that rival fiber-optic without the need of cabling every home.
- Looking further ahead, as VR headsets and augmented-reality technologies are released, the speed and low latency of 5G will allow these devices to give the user an instant internet-augmented reality experience.
All of these will increase the long-term demand for Qualcomm products and the use of Qualcomm patents. After generating relatively consistent revenues the past couple of years, we could see a new growth phase for Qualcomm resulting from the 5G expansion.
Wi-Fi 6E In The Meantime
While 5G is the most talked about subject regarding Qualcomm, Wi-Fi 6E will also be crucial for the company's near future.
On April 23rd, 2020, the FCC voted to open up the spectrum of 6Ghz band for unlicensed use later in 2020. Right now, there are only two bands working, the 2.4GHz and 5GHz. Wi-Fi 6E expands upon these spectrum.
According to the article, this means that there will be a lot more open airwaves that routers can use to broadcast Wi-Fi, which should result in faster and more reliable connections from future devices. The new spectrum quadruples the amount of space available for routers and other devices, which will result in higher bandwidth and less interference between devices.
There are claims that Wi-Fi connections to smartphones could hit 1-2 Gbps over these new networks, similar to the speeds from the mm wave 5G I mentioned before.
This measure by the FCC will surely have an impact on Qualcomm. The company has already stated that their next generation products will support this feature. The following statement is extracted from on Qualcomm's web page:
The latest FastConnect 6800 subsystem is capable of delivering a new class of Wi-Fi speed (approaching 1.8 Gbps), reliability and responsiveness, even in densely congested environments.
Clearly the measure by the FCC will have a big impact on Wi-Fi, and Qualcomm will be there to propel the transition into Wi-Fi 6E. At the moment, this measure has only been taken in the US, but there is hope that by the end of the year the European commission will take the same measure. With the growing number of devices that use WiFi (smartphones, tablets, TVs, smart houses, etc.), the opportunity for growth will be there for Qualcomm.
Many investors are attracted to Qualcomm stock because of its dividend, and with good reason. At the moment, the company has a 3.44% dividend yield, which is very nice in this ultra low interest rate environment. The payout ratio (70.68%) is in a good range, leaving enough room to keep the dividend safe. However, I wish the payout ratio were a bit lower, to reinvest more profits and also make the dividend more safe.
In terms of growth, Qualcomm has considerably increased its dividend per share. In 2004, the dividend per share was just $0.225. Since then, it has grown by 11x to $2.48 per share, and should continue to grow in the upcoming years.
Qualcomm's dividend is nothing spectacular, but it is good enough at the moment, and if the company can continue to grow it in the upcoming years, it will be a nice source of cash flow for investors.
Qualcomm's ever growing IP portfolio and market power provide the company with long term upside, but there are several potential risks:
Litigation and Monopoly
Qualcomm has a long history of litigations, both as a defendant and a plaintiff, mostly revolving around their royalty fees and market power. Other companies consider that they charge extremely high royalties for the use of their IP portfolio, and try to avoid paying them in several ways. There is a risk that in the future, more companies will look to avoid or reduce their royalty payments to Qualcomm trough legal procedures, and their wishes could be granted. The strength of QCOM comes from their IP portfolio, and if they can't effectively enforce their patents, a big part of their business would disappear.
There is also the possibility that, if the government deemed QCOM to be a monopoly, they could take action, potentially reducing the company's strength and revenue. Nonetheless, I consider this to be very unlikely, since QCOM could be deemed of national security importance and be protected as so, since the other big players in the wireless communications companies are non-US entities.
In 2019, each of Apple, Samsung, BBK (Oppo and Vivo) and Xiaomi were responsible for more than 10% of Qualcomm's revenue. A reduction in the purchase of products from these customers, due to the use of their own or a competitor's integrated circuits, or a significant reduction in the demand for their products, would negatively impact Qualcomm.
There is also the possibility that these or any of the smaller OEM customers Qualcomm supplies could develop their own integrated circuit processors, instead of relying on Qualcomm.
Model and Price Targets
To estimate QCOM's future earnings, I used the company's past two years' earnings results to model what next year could look like. To estimate 2021 revenue, I assumed a growth number based on the claims of a 50% growth in average selling price from 4G to 5G chips, and a 125% increase in the sale of 5G devices for 2021. For other numbers I used a combination of guidance and 2 year trends.
Source:10-Q and own Calculations
This is clearly a very simple model, which uses only past information to predict the future. It's not very reliable, so any conclusions drawn from it should take into account a big margin of safety.
To arrive at a price target for QCOM, I used P/E multiples. Below you can see the assumptions as well as the different price targets.
In the last twelve months, the median P/E ratio was around 34. This would represent around 33% upside for 2020, and 191% upside for 2021. However, I believe this PE number might be too high going forward, since valuations could take some time to recover after the pandemic. I believe using the current PE is a bit more realistic, which indicates there is downside for the stock this year (-17%), but great potential upside for next year (82%).
Since the model is very simple, I require a large margin of safety to cover myself from potential problems. Given the uncertainty surrounding the world economy and the stock market at the moment, I would be very cautious about investing in QCOM for the short term. If you have a longer term horizon, and can handle the month-to-month fluctuations in the stock market, I believe Qualcomm has a lot of upside for 2021 and beyond.
Qualcomm stock has experienced a significant decline in the past few months. However, despite the pandemic and the upcoming recession, I believe the company is in a very good position. Their current valuation is very fair, and they should see considerable growth in the upcoming years as they help drive the growth and adoption of both WiFi 6E and 5G. My simple model suggest that there is not much upside in the short term for Qualcomm, but for investors with a longer time horizon, that can withstand the ups and downs of the market, I believe Qualcomm is a good investment.
This article was written by
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