Qualcomm: attractive despite cyclicality (NASDAQ:QCOM)
QUALCOMM (NASDAQ: QCOM), a technology leader, specializing in the design and manufacture of semiconductors and wireless telecommunications equipment, is well prepared to meet the growing and sustainable market demand. A key driver of growth is accelerating adoption of 5G technology, which represents an opportunity for the company to increase its revenues. Additionally, the location of Qualcomm’s manufacturing facilities is diverse, safeguarding the company’s productivity and efficiency against its competitors, whose manufacturing facilities are clustered in East Asia.
Qualcomm ranks highly in our Factor-Based US Large Cap Equity ranking system. This article will explain the factors (quality, value and momentum) that encouraged us to include the stock in our portfolio and why they may shape the stock’s performance over the medium term.
Overview of segments
The company derives its revenue from three reportable segments:
- QCT – Qualcomm CDMA Technologies (86% of Q3-2022 revenue)*: designs and manufactures integrated circuits and system software, with revenue from handsets, RF front end, automotive and IoT,
- QTL – Qualcomm Technology License (13.9% of revenue): covers the licensing and provision of rights to use Qualcomm’s portfolio.
- QSI – Qualcomm Strategic Initiatives (0.1% of turnover): focuses on investments aimed at identifying new opportunities and assisting in the design and deployment of new products and services.
*excluding reconciling item
Quarterly revenue trends for major business segments continue to grow at high growth rates despite global inflationary pressure and supply chain disruptions. This growth can be attributed to increased content consumption, which requires improved hardware capabilities.
Qualcomm has established itself as a market leader while increasing its profit margins. Over the past few years, the operating margin has increased from 16.7% in 2018 to 35.8%, indicating that management has benefited from its earlier strategic investment in quality revenue generation.
In terms of value returned to shareholders, the company’s dividend has grown over the past 19 years, which, if annualized, provides a yield of 2.05% at current market prices.
Additionally, the company returns additional value by continually repurchasing its shares. Over the past three years, the company has repurchased an average of 694 million shares per quarter.
Qualcomm management expects non-GAAP EPS of $12.55 for fiscal 2022, an increase of $4 from a year ago. And for the fourth quarter, the midpoint is $3.15, a quarterly increase of 6.4% on a sequential basis. Based on these assumptions, Qualcomm is expected to deliver exceptional annual results.
For the upcoming period, Qualcomm announced that it has entered into a new multi-year agreement with Samsung which will begin in 2023. The agreement is expected to further increase the company’s revenue for Samsung Galaxy smartphones, including PCs, tablets , reality extensions, and more.
Qualcomm has promising growth prospects, so we will analyze its market positioning using the Porter Five Forces framework. This overview helps to assess the many external business factors that influence the competitive environment of any business.
Threat of new entrants (low)
Existing players in the semiconductor industry, including Qualcomm, Broadcom (AVGO), Advanced Micro Devices (AMD) and others, have invested heavily in R&D and PPE, especially in software development and l material innovation to design and manufacture their products. Thus, it is not easy for new companies to enter and compete. Only very large companies willing to take very high risk can survive.
Threat of Substitutes (Low)
Although customers can substitute products sold by Qualcomm, there is a relatively high switching cost for such a decision due to compatibility and dependency issues. Companies should consider time and successful testing of substitute products. Moreover, even if a customer is willing to accept the high cost, the substitutes are not readily available due to the extreme scarcity in the chip industry.
Bargaining power of customers (moderate)
Currently, customers cannot easily replace products, but we believe they have a moderate impact on Qualcomm’s growth prospects. For example, only three clients contributed nearly half of the firm’s revenue, increasing the impact of concentration risk.
Bargaining power of suppliers (high)
Although many raw materials used by semiconductor manufacturers are standardized, availability is today’s major problem. Therefore, suppliers can negotiate as long as supply chain networks are disrupted. Additionally, as described in its annual report, Qualcomm depends on a limited number of third-party vendors to source, manufacture, assemble and test its products, putting vendors in an advantageous position.
Competitive Rivalry (High)
Although there are few competitors like Intel (INTC) and Broadcom, all companies in the industry have heavily invested in their products and offerings which makes it difficult to exit. Therefore, they are aggressive with their market share and are always on the lookout for opportunities to expand or consolidate through M&A activities.
Qualcomm ranks among the top decile stocks based on our multi-factor ranking system, so it is considered an attractive investment opportunity. It is currently included in our Factor-Based US Growth Equity strategy with a rating of 98.1, as shown below.
Based on factors
As the chart below shows, in 2019 Qualcomm showed a dramatic shift in rankings and was among the top decile of stocks in our universe. Since then, the share price has continued to climb.
Our ranking approach is based on the analysis of nine indicators spread over quality, value and momentum factors. We assign a weight to each factor, and the final ranking is reached after normalizing it to a percentile. You can view the full ranking process outlined in the Factor-Based US Growth Equity Strategy Overview.
Now let’s take a look at some of these factors and explain how they contributed to Qualcomm’s high ranking against its peers.
The ROE of the last twelve months and the measurement of gross profitability are part of our quality factors. Qualcomm’s ROE (TTM) has steadily increased from negative numbers in 2018 to levels above 100% since early 2021 (currently 107.54%). Moreover, the ROE is higher than that of its main competitors, such as Broadcom Inc., Intel Corp. and Advanced Micro Devices Inc., which have ROE ratios of 38.09%, 27.14% and 20.32%, respectively.
Likewise, Gross Profitability, calculated as Gross Profit / Total Assets, has improved significantly over the past few years, showing better profitability, and is currently maintaining its upward trajectory.
Based on our back-testing, we have found that assessing the EBITDA the business generates for each unit of enterprise value (after adjusting for R&D) is a good value driver for identifying businesses with greater cost efficiency. Qualcomm’s ratio has risen sharply following the pandemic, as shown in the chart below.
When it comes to momentum factors, one of the metrics used is the price slope, which helps identify mid-term upsides. Although this factor has declined since the start of the year due to bearish market sentiment, it currently indicates a potential uptrend. As shown in the chart below, the trend is showing signs of reversal. This factor is determined by dividing the 63-day VMA (Volume Weighted Moving Average) by the 252-day VMA.
Qualcomm outshines its rivals in the semiconductor industry when it comes to balancing quality and value. We have plotted ROE (x-axis) against REVU (y-axis) and as shown in the chart below, Qualcomm has a reasonable valuation with good upside potential.
Although Qualcomm has an attractive ranking, its valuation and growth potential are vulnerable to various threats, of which we will name a few:
- Recession risk: Due to rising interest rates coupled with other macro factors such as slowing economic activity, many analysts are expecting a recession by the end of 2022 or early 2023. , demand for the company’s products such as integrated circuits and revenue from royalties collected could decline;
- International political relationsincluding trade protection policies or other governmental and regulatory measures, could limit or prevent the business from achieving its full potential growth in the future (the trade war was a clear example of this);
- Continuous research and development: the company operates in a technology industry that experiences an uninterrupted development cycle, which justifies the need to allocate a large part of the gross margin to R&D to maintain its competitive positioning in the market. However, the expenses incurred will not necessarily translate into additional income in the future.
Finally, Qualcomm’s business held up during periods of high volatility and proved to be less cyclical than other companies. Despite the high level of R&D required to maintain a competitive advantage, the current managerial strategy has generated higher profit margins. The company is well positioned to grow as a semiconductor leader given the current and long-term industry tailwinds driven by 5G, IoT and the metaverse.
Additionally, QCOM has a strong combination of quality, value and momentum factors in our US large-cap equity universe, making it good growth at a reasonable price. [GARP] investment opportunity.