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April 24, 2014

Remaining A Little Nervously Long Qualcomm

I have been a nervous long on Qualcomm (QCOM) for the last six months. Earnings growth has slowed and competitive pressures might mean that will continue over the next few years. The stock continued to hold up well and even had rallied this year to all-time years, however. Unfortunately, the shares are giving back about half of this year’s gain today after the company reported a low quality earnings beat and issued disappointing guidance for the current quarter and the year.

Revenues in the latest quarter grew just 4%, a little below expectations. EPS surprised to the upside but the quality of the beat was low with most coming from non-operating items. Second quarter guidance on revenues and EPS were slightly below consensus. Full year revenue guidance was maintained but EPS guidance was lifted by less than the earnings beat, implying a slightly weaker profits forecast for the balance of the year.

Management pointed to a slower than expected transition to LTE chips in China for pretty much all of the problems in the quarter and guidance. Chinese wireless carriers apparently wanted to clear inventory of older generation phones ahead of the LTE introduction. QCOM’s growth in licensing revenue, reported with a one quarter delay, was impacted by this transition. Management pointed to strength in its manufacturing division (shipping mostly LTE chips now) as a precursor of coming strength in the licensing. The current launch of Samsung Galaxy 5 and likely fall launch of iPhone 6 should get the LTE transition in China fully underway.

So if you listen to management, any current issues are merely a delay in growth. Analysts seem to be buying this thesis as pretty much every analysts maintained their buy rating and several even raised their price targets. Both are unusual when a high profile stock like CQOM drops 4% on earnings concerns.

The bear case is that the issues are more related to competition in China and emerging markets as QCOM lacks a low end solution and has less secure competitive position in the high end on LTE and future generations of chips.

I suspect the answer lies somewhere in between. I admit that is a little wimpy. However, I think it is enough to hang onto QCOM a little longer with the stock trading at just 15 times September quarter earnings with a probable pickup in growth late this year and in 2015. A large and active share repurchase plan remains in place and provides downside support, as does a 2% dividend yield and a recent 20% increase in the dividend. QCOM also has close to $20 per share in cash on its balance sheet.

If the company shows that the transition issues it highlighted are the only real problem, the stock can get back on track and move 15-20% higher later this year. It is not an easy call but I think it will pay to wait.

QCOM is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake’s regulatory filings can be found at www.sec.gov. QCOM is a net long position in the Entermedia Funds. Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.

Posted by Steve Birenberg at April 24, 2014 02:03 PM in QCOM