Qualcomm: Damn The Torpedoes, Full Speed Ahead

Summary

• A variety of concerns pushed the shares well below the sector’s valuations.
• However, 5G and other high-growth arenas should push the shares higher.
• Meanwhile, Qualcomm will reap billions in royalties from rivals.

Photo by Ethan Miller/Getty Images News via Getty Images

A good argument can be made that Qualcomm Incorporated (NASDAQ:QCOM) shares are undervalued. Then again, perhaps there are reasons QCOM trades among the bottom dwellers in the tech industry.

The company was the target of an FTC lawsuit involving Apple (AAPL). Qualcomm is struggling with a supply chain crisis, Apple is developing its own modem products, and 51% of QCOM’s revenues stream from just four customers.

On the other hand, Qualcomm’s product portfolio focuses on 5G, Automotive components and Cloud computing, all areas of robust growth.

Furthermore, Qualcomm’s Technology Licensing (QTL) segment provides nearly a quarter of the company’s revenues through a plethora of patents. Consequently, many of the firm’s rivals pay royalties to QCOM even when selling competing products, and that revenue stream is likely to ramp up with the proliferation of 5G in coming years.

What Is Holding The Stock Down?

There was a time when the primary concern for investors in QCOM was the cyclical nature of the industry. That changed dramatically when the FTC pursued a suit against the company alleging it violated antitrust laws, and Apple and QCOM engaged in legal battles in Germany, the US, the UK and China.

While the initial FTC ruling was against QCOM, it was later overturned. Then late this March, it was formally announced that the US was abandoning its legal assault on the company. Likewise, the wrangle with Apple was also resolved in Qualcomm’s favor albeit much sooner.

Unfortunately, another threat emerged regarding Apple. In an effort to lessen its reliance on Qualcomm’s products, Apple bought Intel’s (INTC) chipset business. Now Apple is working to vertically integrate its iPhone business by building its own cellular modems.

To get an idea of how that could impact Qualcomm, go back to the aforementioned legal battle between the two. UBS analysts estimate Apple paid $5 billion to $6 billion to settle with QCOM, and agreed to pay over $8 in royalties for every iPhone it sells. Now consider that Apple likely provides 19% of the company's revenues.

Of course, only a portion of those revenues would dry up, should Apple succeed in its efforts. There is a licensing agreement between the two that almost certainly governs products Apple might develop, and it is unlikely Apple can establish that its technology does not relate in some way to Qualcomm’s plethora of patents.

Furthermore, the latest 10-K states, “there is a multi-year chipset supply agreement with Apple to support 2020 iPhone product launches.” Therefore, Qualcomm will continue as a primary supplier to Apple for years to come. Nonetheless, investors should closely monitor related developments.

Another concern is an acute supply shortage of a variety of semiconductor chips. Qualcomm’s ability to meet customer demand is largely dictated by the production capacity of Taiwan Semiconductor (TSM) and Samsung.

If you asked me, "what keeps me up at night?" Right now, it is this supply chain crisis we're having in the semiconductor industry. - Cristiano Amon, CEO Qualcomm

As if the current situation weren’t bad enough, Taiwan is suffering from an epic drought. There are concerns that the resulting water shortage could affect TSM’s production. Management has stated Qualcomm has the supply to meet demand for the short to medium term; however, the increased demand is expected to continue for an extended period.

For an in-depth look at this issue refer to a recent article by SA author Kwan-Chen Ma.

If We Could Make More, We Could Sell It

That’s a quote from Qualcomm’s outgoing CEO. While that was a statement referencing the shortage of semiconductors, it also speaks to the robust demand for the company's products.

The latest quarterly results provided a record breaking $8.23 billion in revenue. On nearly every front, the company posted robust growth. The QCT segment was up 81% YoY, with RF front end growing 157%. There was a 79% increase in handset sales, a 48% surge in IoT, and a 44% uptick for automotive. The QTL segment witnessed an 18% revenue increase YoY.

Can the firm continue on this path? There are reasons to believe it can.

The company’s chips are used in 90% of smartphones worldwide, and every 5G phone manufactured today requires a Qualcomm chipset. Now consider ResearchAndMarkets.com is forecasting a CAGR of nearly 125% from 2020 through 2025 for the 5G smartphone market, with sales hitting roughly $823.93 billion.

5G represents the single largest opportunity in our history… - Steve Mollenkopf, former CEO

Add to that the fact that QCOM’s patent portfolio gives the company a royalty fee for every smartphone sold worldwide, and you have a recipe for continued robust results.

Interwoven with smartphones and 5G are the company’s efforts to gain the lead in the RF Front End market. Management has outlined a goal of taking over 20% of the market by 2022.

The company projects the RF front end market for 5G will experience a CAGR of 12%, hitting $18 billion within three years. Considering the firm’s RF front end sales grew 157% last quarter, it is reasonable to assume Qualcomm will hit its target.

However, the good news does not end there.

Of the top 25 automakers, 20 are using Qualcomm’s Snapdragon digital cockpits. The automotive backlog has increased from $5.5 billion in February of 2019 to $8.3 billion as of the last quarterly report.

Source: Forbes

There are now over 150 million vehicles connected to Qualcomm modems, and that number is set to expand.

In January of last year, the company introduced Car-to-Cloud. This service provides manufacturers with the ability to update their infotainment systems via the cloud. It can also relay vehicle and usage data, prompting vehicle owners to undergo maintenance.

Along with Car-to-Cloud, Qualcomm unveiled Snapdragon Ride, its autonomous driving system. That system is capable of initiating safety decisions under unusual circumstances and goes a long way towards providing an autonomous driving experience.

Source: SAE International

The system allows the driver a level 2, “hands-off” degree of autonomy that consumes 20 times less energy than the more autonomous level four or five. Inputs provided through a variety of sources allow Qualcomm’s chip to execute the tasks usually performed by a driver.

I am one that believes the advent of autonomous driving will create a seismic change in our society. Naysayers can dismiss the idea, but it is well on its way, and those that can get in on the ground floor of the development will be richly rewarded.

Qualcomm may be a means to that end.

Valuation

QCOM has a P/E of 23.99x which compares well to the sector P/E of 36.40x. The stock’s forward P/E is 21.53x. The company has a PEG of .83.

The shares currently trade for $140.56. The average 12-month price target of 30 Wall Street analysts is $163.72. The price target of the nine analysts that rated the stock following the most recent quarterly call is $169.11.

Dividend

The yield is just below 2% and has a payout ratio of 36.99%. The 5-year dividend growth rate is 6.50%.

Is Qualcomm Stock A Buy?

Qualcomm is the only manufacturer of a critical 5G chipset in a market that is experiencing rapid growth. The company’s Snapdragon system of chips, which includes a CPU, GPU and modem, are the most widely used in the world.

Add to that the 110 licensing that provide the company with a recurring stream of royalties, the firm’s increasing position in the RF front end market, and Qualcomm’s dominant role among automobile manufacturers, and you have a formula for continued, rapid growth.

Management guides for a 46% YoY jump in sales in the upcoming quarter. Meanwhile, analysts predict a 40% rise in the top line and a 70% rise in the bottom line this year.

Yes, there are concerns, but I see them as virtual speed bumps. While a supply shortage plaques the chip industry, Qualcomm is better positioned than most to ride out the storm. Furthermore, most sales will be deferred rather than lost as a due to a lack of semiconductors.

Regarding the moves by Apple, they will likely result in a reduction of revenue from that source; however, the loss should be manageable, and that development is somewhere on the horizon.

Consequently, I rate Qualcomm as a strong conviction BUY.

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.

I have no formal training in investing. All articles are my personal perspective on a given prospective investment and should not be considered as investment advice. Due diligence should be exercised and readers should engage in additional research and analysis before making their own investment decision. All relevant risks are not covered in this article. Although I endeavor to provide accurate data, there is a possibility that I inadvertently relay inaccurate or outdated information. Readers should consider their own unique investment profile and consider seeking advice from an investment professional before making an investment decision.

Comments

[Bin there dun that]

$QCOM is on sale today.

[cyrano13]

Sorry I fast fingered @Downtown10

[cyrano13]

@dowtown10
It's all about the forecast Nasdaq survey of analysts on earnings is lukewarm.
I am waiting to see what QCOM's forecast is on earnings conference call.

[Flex68]

I used to be in-and-out of MU pretty frequently, back when I felt I was able to 'judge' cyclical movements.

Over the past few years , tho , I've found that I prefer investing in AVGO compared to AMD, MU, TSM, etc.

The chipset mfgs have also delivered very nicely , and I am certainly not believing, or insinuating, that one investment choice is exclusive or delimiting to any other, but AVGO's dividend is the shtuff, and Hock Tan has delivered, time and again, y-o-y.

[User 286]

This is a very written synopsis of QCOM. Thank you. I initiated a position when it was in the dumps and have selectively added to where it's close to a full position in my portfolio today. It's a hard tech to stock not to own...not in love with their management and litigiousness but the company is well positioned for growth. I see this as a hard to find near bargain in the tech sector that is stable, pays a decent dividend and should grow nicely.

[Steve Rasher]

@Chuck Walston Thanks for the excellent update on $QCOM. I have owned it since 1995. Yes, it has had its occasional bumps in the road, but it has always been at the forefront of communications related technology. Apple will try to make its own chipsets, and it may succeed, but the bigger question is what will be the quality of those chipsets as compared to $QCOM's? Lest we forget, Samsung ventured down the same road and guess whose chipsets and modems they now use? Moreover, I have said for some time the vehicle is its next big addressable market. Just ride this juggernaut for growing dividends and long term wealth. Steve

[Chuck Walston]

@Steve Rasher

Good to see you.

Additionally, it is likely Apple will pay royalties to QCOM for the chipsets they produce. Furthermore, there is a reason QCOM is dominant in the space. Better performance. Beware if Apple designs interior chips and opts to use those in place of QCOMs.

Chuck

[Steve Rasher]

@Chuck Walston That's what happened to Samsung. They developed their chips, but when they started selling phones with them, the performance reviews were not very kind, to say the least. Thus, they reverted to using $QCOM product. It will be interesting to see what Apple does. Steve

[Chuck Walston]

@Steve Rasher

I have to say, I would chuckle a bit if Apple committed the same error. I don't know why, as I'm invested in Apple? I guess there is a side to me that doesn't care for the way some of the dominant companies throw their weight around, even when it benefits me, the shareholder.

Chuck

[ArtfulDodger]

CW:

That is an excellent piece. It provides the best rundown of both sides of QCOM's products and earnings that I've seen. Good work!

A couple of things: One, you did not address the company's debt, which has sneaked up fairly high in the last few years. Two, you may know some, but two groups I work with in different areas and one in stocks have asked tons of people about wanting or not "autonomous driving; and we've yet to get a "yes" answer from anyone. Most would not mind some partial autonomous driving on the road, but no one would even try it with local driving. They don't even understand the "why" of pushing drivers toward that end.

Thanks for the piece!

I remain, the ArtfulDodger

[Chuck Walston]

@ArtfulDodger ,

Appreciate the response. With every article, I must choose to some some material due to the length of the piece. I agree that the debt profile is not what it once was, but my short answer to that is Argus rates their financial position as "medium high."

Regarding autonomous cars. Have you driven the near autonomous Tesla? I agree that there is a great deal of resistance to the idea; however, imagine your blind neighbor tooling around town in an autonomous. How about an 85 year old that lost his/her license and has no other choice. How often will others see these folks "driving" before they take the plunge. Doing your work, or studying for exams while "driving." How about the crew heading to Vegas, watching the ballgame while drinking a brew?

Chuck

[adowns]

@Chuck Walston I think the first big use of autonomous driving will be to replace long-haul truck drivers who are in short supply and whose shifts are limited due to DOT regulations.

[Bin there dun that]

Great article, Chuckster. You NAILED IT! $QCOM is my largest holding right now, fwiw.
Hope you guys are all staying healthy and doing good! 😊

[Chuck Walston]

@Bin there dun that

Hey, buddy. Long time, no see. We are well, hope ya'll are the same,

Chuckster

[Guy at Work reading SA]

I just hope for the day in 20xx where virtually everything is connected wirelessly and QCOM has a role in that future. If they are the leaders in wireless tech then it will be a very beneficial investment.

[cyrano13]

Everybody loves QCOM, but nobody is focusing on the price increases they and all others will have to pay the fabs. Waiting for a much lower entry price.

[Downtown10]

@cyrano13 Assuming you’re correct that the fabs will be charging more, why do you believe QCOM won’t be able to pass along those price increases to their customers? When chip demand is high and supply is low there is no way QCOM will be making LESS profit per modem sold.

[skymole]

@cyrano13 There is a gap in the chart just below 100, if I recall correctly. I bought a starter portion around 128, but it would not surprise me if that gap were filled, and if it is, that is the buying opportunity for long-term investors...

[tmoffat]

Nice article Chuck. Thank you. And a special thank you for your service. Another thing of interest regarding QCOM is the extraordinary % of sales the company spends on R&D. I am not remembering the amount but think it was over 17%.

[Mct10]

I bought the stock at $160 and still waiting to get out of it. The reason I thought that it was undervalued when I did. This article is great and will consider buying more instead of cutting my loses.

[Koshien Kid]

@Mct10 If your purpose be a long-term holding for your portfolio I encourage you to stay with QCOM. Easier for me with a basis of $54; but the author’s thesis is correct. Radio is A-D-A is much tougher to master than purely digital hardware. That’s why there’s only ~20 companies in the world who can do this, and of the top 5 Qualcomm is the only commercial supplier. The others are all military contractors. The combination of arcane scientific wizardry, global scale and a thicket of patents makes it very tough to break into this market. Apple will soon find out.

[metoo5]

@Koshien Kid - Apple doesn’t need to break in to the market. Vertical integration means bringing its own market and selling to itself.

[coloradan]

Have invested in QCOM off and on since the '90s. One thing I learned is that QCOM is usually ahead of the curve in developing IP. And when you're ahead of the curve, it can take time for the curve to catch up so you need to be patient. I've done well buying it when I thought it was cheap - especially after sell offs. I've been building up a position in recent months. I do it with in-the-money call leaps as the time premium isn't that high and I get a nice 3-4x leverage play. Does it work for me? Yep, I made over $70k last year and year to date, altho I'm a bit underwater on my current position (about $5k), but the calls don't expire until 1/22 and 1/23. Yes, QCOM has some tough times ahead short term, but long term they'll do well. Thanks for the article.

[57seagull]

@coloradan I, also, use the same strategy. My 1/15/21 $90 LEAPS ended with an $83,027 gain. My 1/21/22 LEAPS likewise are underwater at this time. In addition I continue "nibble" to add to my QCOM position. Meanwhile I also thank the author for his well written article.

[JPV]

I am a bit surprised with the article. I fully agree that the company has a good future but I think there is a lot of uncertainty over when this will start to have its full impact. If I look at the price chart I have the impression that a lot of the future growth, especially this year and next is already in the current price and therefore the stock is not undervalued at all at the moment. Ref: FAST Charts.

[Chuck Walston]

Chuck, thank you for this article. I found it easy flowing while disclosing a plethora of information. Wish more writers had your knack! Keep up the great research and delivery.

[craftbrewinfo]

@Chuck Walston another great article. I’ve had my eye on TXN and that shot to the moon .. qualcomm ? Same thing .. damn the torpedoes is right.. i may just have to jump in and Go ! Thought provoking as always

[Chuck Walston]

@craftbrewinfo,

Uh huh...I know what you're up to. You compliment my work so you can get out of giving me a brew. Ain't working. I DEMAND a free brew !!!

Chuck

[craftbrewinfo]

@Chuck Walston I'm drinking it while I post on your threads,cheers :-)

[Jorel Boston]

Great Article. Definitely confirmed reasons why I own, and why I purchase more & more. Whenever I see The Fifth Element I always wondered what chips have those cars flying 😂
-Long QComm

[Gus McCrae]

Anybody have any thoughts on specific opportunities for QCOM around the Nuvia acquisition? Could it mean that QCOM might actually deliver the often-promised but never realized single device that serves as both phone and laptop/desktop? And/or, is the Nuvia team going after Nvidia/AMD? Either one of these scenarios would be amazing for QCOM with decent execution. Thougths?

[Chuck Walston]

@Gus McCrae

I considered discussing the Nuvia acquisition, but I also have to balance content with article length. I view the acquisition as a strong positive. I'm of the opinion the deal will enhance QCOM's already strong advantages in development of new tech.

Chuck

[Gus McCrae]

@Chuck Walston Yes, I have no doubt the Nuvia acquisition will enhance QCOM's ability to develop new tech...the question to me is whether or not there is a specific plan they are executing on to do something major with Nuvia? The "major" things I can think of are (1) a single mobile phone device that also serves as a suitable laptop for most users, and/or (2) GPU's to take on Nvidia/AMD.

[metoo5]

@Gus McCrae - QCOM will have to compete with AMZN graviton in the server space and Apple outside of that, both of which have years of head start and are vertically integrated. Nuvia is oriented to the data center and QCOM’s first priority-since they killed their own data center ARM initiative-is mobile, and that after they abandoned their own custom ARM in favor of reference designs. It will take a good bit more than decent execution to pull off.

[Vandooman]

Good article. You confirmed my view of the stock. I am very long and staying very long.

[Chuck Walston]

@Vandooman ,

Good to see you, and glad to be of service, Chuck

[BM Cashflow Detective]

Qualcomm's year-on-year change in revenues and earnings are better than the median among its peer group.

Qualcomm is expected to benefit from sharply increasing revenues this year. But in the following year the growth prospects seem to flatten a little.

After that, the company appears to face weaker demand from China. Chinese OEMs are withdrawing new 4G device orders and managing their inventory in advance for the transition to 5G. As a result, Qualcomm expects to have a significant impact on device shipping as sales and sell-through growth rates realign and channel inventory levels in China are reduced. So far, so bad.

However, Qualcomm expects future healthy growth momentum brought about by new product launches, including devices with 5G chipsets, and growth in Articial Intelligence (AI) that can turn vehicles into self-driving cars.

This will have a significant impact on future Estimated FCF Growth with an average growth rate of 21.50%. This could mean an average total annual return of 18.7% over the next 18 months.

The paths of progress are neither short nor easy. The key to progress is not the rapidity of the pace, but the uninterrupted movement of the forward.

Therefore, $QCOM is an extremely successful company over the long term and the stock is a promising investment.

[Chuck Walston]

@BM Cashflow Detective

Thanks for weighing in,

Chuck

[rj.farr]

@BM Cashflow Detective

Hi BM,

Was reading an interesting article that involved streaming services, cable and satellite TV. I'm long on Discovery and Viacom and was looking for validation. The article referenced how 5G would enable wireless Internet service, which is appealing in my list of options in Seattle suburbia.

Our phone provider is T-Mobile and they just recently blasted me with an announcement that 5G was available here. There has not been much of a reason to get excited about that but a few of the pieces of the puzzle fell together.

TM had been pursuing their own TV offering and just recently threw in the towel because there are plenty of more popular and established streaming options. They hooked up instead with Google's YouTube TV which has a boatload of programming for less than we're shoveling out for Direct TV. We also overpay for a wired Internet connection.

Our last child will be off to Tucson for grad school in the fall so we can dump Direct TV and its singular attraction - NFL Sunday Ticket. I did realize that it will mean upping our phones to 5G and I'm very happy with the mid-priced Google Pixels, so we'll have a go-to plan.

I imagine people with all the major phone carriers will be evaluating a similar scenario where they can ditch traditional wired/satellite programming and/or Internet service. This will create one of the "super cycles" normally attributed to a very successful Apple iPhone launch. But the sales will be from everyone's favorite brands and useful on whatever carriers have reliable 5G in their appropriate zip codes. And QCOM will get a slice of just about every transaction and upgrade that follows.

[Long QCOM, TSM, AVGO, QRVO & MU]

[BM Cashflow Detective]

@rj.farr
Thank you for your very interesting and insightful comment. I liked it very well.

Please take the following into account in this context. For us as shareholders, the decisive factor is not how much a new technology will change or improve society, but rather only whether the companies involved can convert the revenues into increasing free cash flow over the long term. Only then are lasting values created. Everything else disappears again in the infinite universe of the constructive destruction of capitalism.

"Never take your eyes off the cash flow because it's the lifeblood of business."
- Sir Richard Branson, business magnate, investor, author and philanthropist

In this respect, you are excellently positioned with your shares. Congratulation. Just keep these successful winning stocks forever.

We always need the identity of a winner.

Winners attract opportunities.

Only your own deep conviction as a winner makes the crucial difference to be successful in the long term, compared to everyone else with excruciating doubts.