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May 02, 2013

Qualcomm Raises Concerns But Story Intact

Despite reporting results largely in line with estimates and slightly raising full year guidance, Qualcomm (QCOM) shares traded down sharply following its earnings report. Investors were disappointed with margins, especially looking ahead to next quarter when the company expects them to remain under modest pressure. The margin guidance led to June quarter EPS being forecast slightly below current analyst estimates. For a high growth stock like QCOM, there is no room for error, even when it is just shifting earnings from one quarter to the next. As a result, the shares headed lower.

The bear case on QCOM is that the high end smartphone market has matured and demand is shifting to emerging markets where the company offers lower priced semiconductors that produce lower profit margins. If this sounds familiar, it should, as the same issue is troubling Apple where there is great focus on whether the company will issue a low cost iPhone for emerging markets and if so whether it will be dilutive to profit margins.

On the conference call I thought Management explained well what was going on and the Street chose to ignore bullish comments beyond the June quarter. In addition, with a new iPhone likely launching in the fall and a big push by Samsung and HTC for their new phones happening right now, I think the street may be too conservative in their outlook for the June quarter. Despite my view that the long-term story is intact, I think QCOM will remain in the penalty box until a better earnings report is issued or timing on the next iPhone launch is confirmed.

While we wait, keep in mind that QCOM just reported 24% top line growth and 16% EPS growth. Next quarter, the one with lower than expected margins, is expected to show revenue growth of 30% and EPS growth of 23%. The stock is trading at a P-E of less than 14 times 2013 estimated earnings, despite this growth. Furthermore, QCOM has about $17 per share in cash on the balance sheet contributing very little to EPS. Earlier this year, the company recently sharply raised its dividend and share buyback, showing confidence in the long-term outlook. I believe next quarter will show that this is the winning position on QCOM, so I plan to hold the shares in client accounts.

Qualcomm and Apple are 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. Qualcomm and Apple are net long positions in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, entertainment, leisure, consumer retail, communications, and related technologies. Steve is portfolio manager of Entermedia, owns a controlling stake in Entermedia’s investment management company, and has personal monies invested in the funds.

Posted by Steve Birenberg at May 2, 2013 09:28 AM in QCOM