Qualcomm (NASDAQ: QCOM) is the leading manufacturer of mobile chips reported earnings recently. While revenue fell short of forecasts, the company actually increased its guidance for FY14 with increased confidence in the market outlook. An increase to guidance is not only positive for Qualcomm but other companies with exposure to its end markets.
There is upside to companies with emerging market exposure in smart phones and playing the trend through the chip manufacturers may carry less risk from the rollout and success of particular products like that of mobile players like Apple (NASDAQ: AAPL).
Qualcomm Incorporated designs and manufacturers digital communication products and services for code division multiple access (CDMA), orthogonal frequency division multiplexing (OFDMA) and other wireless and mobile technologies. If you have a tablet or mobile phone, there is a good change Qualcomm has content in it. It reports in four segments, Qualcomm CDMA Technologies (QCT), Qualcomm Technology Licensing, Qualcomm Wireless & Internet and Qualcomm Strategic Initiatives. Its products are used in voice and data communications, networking, application processing, multimedia and GPS.
In addition to selling chips into the mobile market, Qualcomm receives royalty payments for its CDMA phone technology. The royalty payments are based on the average cell phone price, which is declining, and will result in declining payments in that business going forward.
Competitors include Motorola Solutions (NYSE: MSI), Broadcom (NASDAQ: BCRM), Ericsson (NASDAQ: ERIC), Alcatel Lucent Soci (NYSE: ALU) a month other circuit and mobile technology manufacturers. There is also increasing competition from the Chinese manufactures, particularly in devices that fit into lower price points.
Qualcomm 1Q14 Earnings Report Recap
Qualcomm reported earnings of $1.26 per share on January 29, 2014 which beat consensus by $0.08. Revenue of $6.6 billion fell short of consensus by $70 million and was up by 10% y/y. While consensus estimates were not broadly trimmed by analysts, the softer than expected smart phone sales at Apple and Samsung already reported had already resulted in reduced expectations from Qualcomm by the Street. It was priced into the shares following the results of those firms.
The gross margin in the quarter was 59.1%, up 100 bp from the prior quarter but down 370 bp y/y. QCT margins improved in the quarter to 19.6%, an increase of 380 bp from the end of the prior quarter and a positive surprise behind cost cutting measures. Management does not expect this to continue as royalty payments based on ASPs of CDMA phones will decline.
In terms of volumes, the Qualcomm shipped 213 million mobile station modem (MSM) chips in the quarter versus guidance of 195 – 210 million. Management increased guidance to $5.00 – $5.20 per share from $4.95 – $5.15 per share (current consensus $5.09) and also maintained revenue guidance of $26-$27.5 billion despite the sales shortfall on the quarter. The guidance was a bigger surprise considering it issued 2Q14 sales guidance of $6.1 – $6.7 billion and EPS of $1.15 – $1.25, short of consensus at the time of $6.72 billion and $1.26, respectively. Cost cutting measures and other margin enhancing actions are having a larger impact than anticipated.
The company will generate strong FCF and has noted it will return 75% to shareholders through repurchases. It had cash at quarter end of $31.6 billion, up sequentially from $29.4 billon. It paid out $590 million in dividends and repurchased over $1 billion in shared during the quarter.
Shift to Emerging Markets – China Mobile Important to 2H14 Guidance
Qualcomm, similar to Apple’s results earlier this week, cited a shift in demand for smart phones. Emerging markets, China in particular, are driving the incremental growth with the developed markets like the US starting to flatten off. Management stated that China Mobile’s roll out of LTE technology led to their increase in 2H volume and EPS expectations.
Along these lines, management previously stated it expected smartphones to grow at a CAGR of 20% between 2012 and 2017 with emerging markets growing at 30%. In the Chinese market, 3G only has a 38% penetration rate. When consumers shift to 3G in China, Qualcomm’s value added content will increase in the market and drive increases sales and margins.
Conclusion – Strong Play on Mobile in Emerging Markets
The company’s technology currently addresses 100% of the global handset market and the shift in emerging market to higher end technology like 3G will increase the dollar value of content per device and act as a positive mix shift to margins. In addition, the tablet market presents and incremental opportunity for expansion with more and more devices being sold that include mobile service. Owning Qualcomm compared with Apple gives an investor much broader exposure and less dependency on other products. It is a lower risk way to play mobile growth and expansion into emerging markets and its policy of returning cash to shareholders is a further positive.
What are your thoughts on the future of Qualcomm in the mobile space?