- The shipment of 5G phones and other devices is set to soar at the end of 2020 and in 2021.
- The use of Qualcomm products in the next iPhone will significantly boost sales.
- Trade tensions loom, but a new TSM plant will provide some safety in the future.
- This idea was discussed in more depth with members of my private investing community, Nail Tech Earnings. Get started today »
Co-Written with Elazar Advisors, LLC
Qualcomm (NASDAQ:QCOM) has been on a run despite the news of tensions between China and the US. Optimism around 5G has offset trade concerns. With the surge in 5G smartphones and other devices for the end of 2020 and 2021, Qualcomm can have significant upside.
5G: The Main Catalyst
Most of Qualcomm's 2021 upside comes from the development and expansion of 5G. According to the company, 5G could deliver average rates of over 100Mbps. Also, traffic capacity could be increased by 100x, while reducing latency to 1ms, 10 times lower than 4G.
The upgrade from 4G to 5G is expected to be far more important than the upgrades to 3G or 4G. The ultra-fast speeds and low latency that 5G provides will be significant for many products.
The deployment of 5G in the US is well under way with all the main carriers. The FCC, with its 5G FAST Plan, is pursuing a strategy to help push the development of 5G. The plan has three components: pushing more spectrum into the marketplace, updating infrastructure policy, and modernizing regulations.
At the end of April, on their Q2 earnings call, management reiterated their guidance of 175-225 million 5G units for 2020. This assurance by management is very important given all the macro concerns. But since 5G will be the main growth driver for the company in 2020 and the following years, they can plow through macro concerns.
From the chart above, we can see that 2020 and 2021 are the key years for 5G growth in devices. The number of shipments is set to increase exponentially, which is, of course, good for Qualcomm. Their 5G chips are higher value-added products than their 4G, so this should translate to higher revenues and earnings.
Internet of Things (IoT)
5G is not just about smartphones. 5G is also about driverless cars, edge computing, and more. Some of the most exciting technologies being developed at the moment are those related to the Internet of Things (IoT). 5G, by increasing speeds and reducing latency, will allow for new and better devices that are connected to the internet.
In simple terms, IoT refers to devices like sensors, wearables, and others that are all connected together via internet. In theory, the connection, as well as the automation of systems, allows these devices to gather and analyse information, share it, and take actions in real time.
We're already seeing more and more things connected to the internet. Smart homes, smart kitchens, smart TVs, etc. And more will come. In factories, schools, hospitals, etc.
So, this next-gen ramp is not just about smartphones. For comparison, according to the same source, the market size for smartphones in 2018 was $522 billion. So, by 2021, IoT market size could be around 80% of the 2018 market size for smartphones. The size of IoT is meaningful and will be an added driver to this and next year's results.
In the chart above, we can see that the market size of IoT devices worldwide will grow exponentially. In this huge and expanding market, Qualcomm will be a key player. They have the patents and the products to benefit from this growth. This can be one of the key growth drivers for the company along with smartphone sales.
The Apple Conundrum
Apple (AAPL) and Qualcomm have had their share of differences over the years. After a surprise settlement last year, the two companies agreed to work together on the next iPhone. Apple is expected to debut its first 5G iPhones this fall, powered by Qualcomm's X55 modem. This will be a huge revenue catalyst for the company.
Imagine, they are adding Apple to revenues. It's pretty huge.
However, according to a report by Fast Company, the partnership may not last long. The report states that the proposed antenna by Qualcomm is too large for the slim profiles Apple is aiming in future phones. On top of that, the report said: "Apple still feels it's getting screwed on royalties by Qualcomm." For these reasons, the report suggests that Apple is preparing for a split from Qualcomm.
Another article mentioned a similar view. The article quotes Apple CFO Luca Maestri saying: "As you know, we purchased the baseband activities from Intel. And obviously, we want to develop that technology because we consider it's a core technology for us." Apple wants to, ultimately, bring it in-house which is not good for Qualcomm.
It's something that needs watching for sure.
Short term, I think we're OK, but after this initial 5G ramp, we need to watch for hints of any shakeup in this relationship. If there are, we want to be far away from Qualcomm. Apple's too big and important to lose.
Apple bought Intel's modem business with plans to develop its own antennas and modules. Given the challenges of developing 5G modems and antennas, it's likely they will have to go with Qualcomm products for the time being. However, if they switch to their own chips in the future, a big part of the upcoming business for Qualcomm would go away. One source estimates the switch could be done by 2022 or 2023. It's not an immediate risk, but important to monitor.
Trade War Risk
The ongoing tensions between the US and China are another significant risk for Qualcomm and other semiconductor companies. If trade tensions escalate and measures by either government are taken, Qualcomm could be negatively impacted.
On May 15, plans by Taiwan Semiconductor (TSM) to build a $12B chip factory in Arizona were confirmed. TSM is a major supplier for Qualcomm, and having them produce in the US would be a safety net. It would reduce supply risks in case of a trade war or another event like the COVID-19 pandemic that can affect supply chains.
However, the plant is not yet being built. It will take some time for it to be up and running, so the risks are still there for Qualcomm in the short and medium term.
Model and Price Target
Based on the projected growth for 2021, we have a significant upside for 2021 (see full model: paywall). The inclusion of the X55 modems in iPhones, the growth in sales of other 5G phones, and the rise of IoT all provide significant growth opportunities for Qualcomm. Our model reflects that. Our projected EPS for 2021 is around $7.20 a share versus the Street at around $6.00. Using a PE ratio of about 19.5, our price target is $140 implying the stock has a 63% upside.
We have several requirements to give a stock our strong buy rating.
We need our quarters higher than the Street. We don't exactly have that but we'll be doing more work this month on Qualcomm.
We need more than a 45% 12-month upside. We have that.
We need wow, meaning the honest ability to say wow. 5G is a wow, but the trade and Apple concerns offset that.
Qualcomm falls a little short of those criteria required for a Strong Buy, but we are still bullish on the company's upside. We currently have a position in our model portfolio for subscribers.
Qualcomm has been on a nice run for the past month, and we believe it can continue to perform well in the short and medium term. Our model predicts a significant upside for 2021, given the surge in demand for 5G smartphones and devices, as well as the use of a Qualcomm antenna in the next iPhones. Overall, we are bullish on Qualcomm. That said, it's not an official buy rating for us. We think we have better ideas to get big. But Qualcomm's stock still has profit opportunities.
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