Qualcomm: Huawei, Finally!

Summary

• The Huawei license deal adds substantial profits for Qualcomm.
• If not for COVID-19 impacts on smartphone sales, the company would easily top a $7 EPS target.
• The stock remains cheap with a normalized EPS goal approaching $8.

The FQ3 earnings for Qualcomm (NASDAQ:QCOM) were a side show to the big license deal with Huawei. The wireless technology leader is now firing on all cylinders as 5G reaches full speed boosted by needs for better internet connections outside the office. The stock has rallied to new highs above $105, but my investment thesis still remains bullish here.

Image Source: Qualcomm website

Huawei Trumps 5G

Qualcomm reported FQ3 results and guided toward FQ4 results with a prime focus on the global deployment of 5G. Not surprisingly, the announcement of a patent license agreement with Huawei trumped any news on growing revenues from 5G or any impact from COVID-19.

Huawei agreed to a new settlement agreement that includes a $1.8 billion payment to catch up from amounts not paid starting with FQ3'17 or over 3 years ago. The Chinese smartphone manufacturer had made interim payments of $600 million in FY18 and $450 million in FY19. The total royalty amount for the 13 quarters equates to $2.85 billion or ~$219 million per quarter during the period in doubt.

Using this estimate of $219 million in quarterly royalty revenues from Huawei at pure profits and 1.1 billion shares outstanding, the license deal adds around $0.75 in annual profits to the equation for Qualcomm. Investors should remember that the company had long estimated that the lack of license revenues from both Apple (AAPL) and Huawei for a period cost Qualcomm up to $2.25 in annual earnings per share.

Huawei is very important licensee after becoming the leading Chinese smartphone manufacturer in the last couple of years. The company now competes with Samsung (OTC:SSNLF) for the global leader with 17% market share in Q1.

Source: Counterpoint

Analyst John Vinh of KeyBanc believes the Huawei license deal will lead to an eventual chip agreement similar to what occurred with Apple (AAPL), especially with the Chinese operator blocked from producing silicon outside China. Snapdragon modems from Qualcomm are the premium chips on the market and the lack of access to Qualcomm leaves Huawei in a disadvantaged position in 5G phones.

Full Potential

The biggest problem with Qualcomm is that their quarterly financial results always have a catch. Whether a missing royalty payment or temporary smartphone demand issues, the numbers never seem to reflect the full potential of the wireless technology leader.

The impressive FQ4 guidance comes with the forecast of a 15% reduction in 3G, 4G, 5G device shipments. In addition, the agreement to supply Apple with 5G chips kicks in now, but the company is expected to have delayed 5G iPhone shipments due to COVID-19.

In essence, Qualcomm has solid September quarter expectations, but the investor community has to project what the results could be in a normal environment. The company has had the potential to generate a $7+ EPS for years now with the addition of Huawei and Apple into the licensing program, but those numbers have to wait until smartphone demand normalizes.

The FQ4 EPS forecasts jump to $1.05 to $1.25, but COVID-19 is causing a $0.25 impact. The quarter could see the EPS reach $1.50 for a $6.00 annualized earnings rate. The number is impressive considering Qualcomm only earned $0.78 last FQ4, but investors have always hoped for an EPS number topping $7 and approaching $8 with the full benefit of 5G.

EPS estimates for FY21 have immediately jumped to $6.32 per share with FY22 reaching $6.89. The December quarter could finally be a blowout quarter with the Huawei license deal and 5G iPhones in full force. Naturally, some analysts have FY21 EPS estimates starting above $7 now.

Data by YCharts

Takeaway

The key investor takeaway is that the license deal with Huawei finally allows the wireless tech giant to reach their full earnings potential above $7 per share. If the company can actually reach $8 for FY22, the stock only trades at 13x more normalized earnings. My target remains for Qualcomm to reach at least $120, if not far higher.

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Analyst’s Disclosure: I am/we are long QCOM, AAPL. 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.

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.