- 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.
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.
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.
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.
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.
This article was written by
Chuck Walston is a U.S. Army veteran and a retired law enforcement officer with approximately 20 years of experience as a retail investor. He focuses on dividend stocks and concentrates on companies with competitive advantages and strong balance sheets.
Chuck is a contributing author for the investing group The Dividend Kings which focuses on helping investors safeguard and grow their money in all market conditions through the highest-quality dividend investments. Features include: 13 model portfolios, buy ideas, company research reports, and a thriving chat community for readers looking to learn how to invest more intelligently in dividend stocks. Learn More.
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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