Earnings Updates: Apple, Google, and Qualcomm

This quarter I am trying a different approach that hopefully saves clients time and increases readership of the quarterly earnings updates. I will write short paragraphs on several companies at a time as they report highlighting a few key items in the reports and looking ahead to future potential of each stock.

Earnings season is off to a mixed start for Northlake Capital Management. Google (GOOG) had a good report highlighted by improved revenue growth. The stock responded nicely. Apple’s numbers were pretty much in line with expectations during a transitional quarter ahead of new iPhones and many an iWatch to be introduced this fall. AAPL shares have moved up to a new recovery high, not far below the all-time high in the fall of 2012. Qualcomm (QCOM) spoiled the party as despite an excellent report, the company cuts its 2014 outlook due to conflicts with Chinese manufacturers over payment of license fees. QCOM shares dipped about 7% due to uncertainty about future growth in China.

Here is a bit more detail on each report.

The highlight of Google’s report was a pickup in advertising growth. Investors have feared that GOOG has reached a point where its revenue growth rate would gradually decelerate. This is partially due to the maturity of search and also to more competition for advertiser dollars form Facebook, Twitter, and other internet ad platforms. In the latest quarter, top line growth picked up to over 20%. Maybe more importantly, GOOG broke out data on its Google.com website vs. partners sites (partner sites have Google search embedded). Google.com search growth was above 30%. Finally, there was small improvement in ad pricing, which fell 6% vs. street expectations for a 7% decline. Remember that Google desktop ads are priced higher than mobile ads so as the mix has shifted toward mobile search (smartphones and tablets), pricing has come under pressure. Should pricing pressure alleviate as expected, GOOG will get a nice growth benefit. GOOG shares have lagged the market this year, gaining only 5%. I think a move to $630, or 20 times 2015 estimated earnings of $31.50, is in store now that investors are feeling better about sustained top line growth trends.

Apple reported a dull quarter by its usual standards. Actually, a better way to state it is that investors reacted little to Apple’s results, an unusual occurrence. Earnings came in slightly ahead of expectations with revenues just a bit below the Wall Street consensus. The implication here is that profit margins were better than expected and that was exactly the case. Apple shares have rallied sharply this year after a difficult period as investors anticipate a big upgrade cycle related to the larger iPhone 6 and a significant new product category for the iWatch. I believe the stability in gross margins is equally important as the bear case in Apple has been that its profitability would fall as the smartphone market matured and its premium prices would face pressure. Whether through sustained demand or effective cost management, gross margins have consistently held up better than expected over the past few quarters. Higher margins assumed in the future means more earnings power. It also undercuts the bear case which has helped increase confidence and allowed AAPL’s P-E to expand. I think the iPhone 6 upgrade cycle will surprise to the upside driving 2015 earnings above consensus of $7.00. A slight expansion in the P-E and credit for a bit of the balance sheet cash ($27 per share), should drive the shares to new all-time highs around $120.

Qualcomm’s report was particularly frustrating as the results were quite good with demand for its chips and the associated licensing revenue both coming in stronger than expected. Unfortunately, the company announced that disputes with the Chinese government and certain Chinese licensees would lower earnings power over the next few quarters. It appears that an ongoing investigation into Qualcomm’s “monopoly power” has given Chinese smartphone and tablet manufacturers an excuse to withhold license payments. China is QCOM’s most important growth market so even though the impact to revenue is small (Chinese companies use mostly low end chips), the long-term growth rate impact could be large. This has led to compression in QCOM’s multiple as the stock has fallen about 8%. This is an impossible situation to analyze but QCOM has faced license battles before in Japan, Korea, and with Nokia. In all cases, QCOM came out fine. China could be different and the stock likely is in limbo until the situation is resolved. There remains risk other licensees in emerging markets could follow China’s lead. I think the shares have compensated for the China risk as they now trade at less than 14 times forward earnings estimates. QCOM is buying back a lot of stock has a cash rich balance sheet. Northlake plans to wait out the China issues and looks to a very strong iPhone demand cycle to support QCOM shares while we wait.

GOOG, AAPL, and QCOM 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 regulatory filings can be found at www.sec.gov. GOOG, AAPL, and QCOM are net long positions in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, leisure, and related technologies. Steve Birenberg is the portfolio manager of Entermedia, has personal monies invested in the funds, and controls Entermedia’s General Partners.

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.

Qualcomm Guidance Raises Questions

Qualcomm (QCOM) reported 4Q13 results mostly in line with expectations. However, guidance for 2014 indicated slower growth in units and a slight decrease in average selling prices. The guidance led analysts to reduce their outlook for revenues and operating income for 2014. However, QCOM’s commitment to large share repurchases leaves earnings estimates unchanged at a little over $5.

Two issues are leading management to be cautious. First, QCOM is increasingly reliant on just Samsung and Apple, which dominate high end smartphones and use their buying power to keep QCOM pricing and margins in check. Second, QCOM’s strength at the high end leaves it underexposed to the booming market for low end smartphones, particularly in China.

I believe the cautious outlook warrants a reevaluation of the upside in QCOM’s shares. The company has an analyst meeting later this month which should provide greater clarity on the 2014 and longer term outlook. I think the shares are worth holding for now as management is very good and is likely to reassure investors at the meeting. In addition, the shares are not expensive. At less than 14 times forward earnings estimates without considering the company’s large cash balance. The shares have bounced off their post-earnings lows. I think that stability indicates underlying support for the bull thesis and keeps risk in check heading into the analyst meeting. As a result, I am comfortable continuing to own the shares while looking for further detail on the 2014 outlook and what it means for long-term growth. Lower expectations might be a good thing for QCOM shares after a long period as a Wall Street favorite.

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. 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.

Qualcomm Fights Offs Bears

After a lot of worry on the part of investors, Qualcomm (QCOM) reported solid June quarter results and provided guidance for more the same. QCOM shares have lagged in 2013 due to investor fears about a slowdown in high end smartphone demand. Despite signs of slower growth (offset by a positive surprise in iPhone volumes last quarter), QCOM hit its numbers. QCOM also is buying back its stock aggressively showing confidence in its outlook. The shares trade at just 12 times EPS estimates unadjusted for $15 per share in cash. With revenue, operating income, and EPS all set to grow at least double digits even in a tougher competitive environment, the shares look inexpensive. Apple’s next iPhone introduction could serve as a positive catalyst and allow the stock to catch up to the market’s big gains this year. A a target in the mid $70s, providing 20% upside remains realistic.

Besides just hitting numbers and guidance, upside in the quarter was driven by good pricing. With average selling prices for smartphones falling as mix shifts to low and mid-end phones in emerging markets, there is fear that QCOM’s margins will come under pressure. If this sounds familiar, it is because you hear the same thing about Apple.
I think these fears are overdone as QCOM and AAPL both showed this quarter that they can navigate moderately falling average selling prices and maintain decent margins. The next quarter or two should provide insight into whether my thesis makes proves correct. If so, upside in QCOM is substantial as the multiple expands and earnings estimates rise slightly. As with AAPL, a large share buyback, incredible financial strength, and cheap valuation provide support and set up an attractive near-term risk-reward tradeoff into new smartphone introductions this fall from Motorola (Google), Apple, and Samsung.

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.

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.

QUALCOMM looks good as EMC continues to struggle

Last week two of Northlake’s stock holdings in the technology sector reported earnings. The verdict was mixed with QUALCOMM (QCOM) reporting another outstanding quarter and issuing guidance for 2013 above Wall Street expectations. EMC Corporation (EMC) reported earnings in line with recently lowered Wall Street estimates but issued slightly disappointing guidance.

As would be expected, QCOM shares responded well to the company’s earnings and guidance, rising more than 5%. Interestingly, after an initial sell-off, EMC shares firmed up. In fact, backing out a 20% drop in the shares of EMC’s 80%-owned subsidiary VMWare (VMW), the implied valuation of EMC’s 100%-owned storage businesses ended the week higher. Of course, a significant part of EMC’s valuation is VMW but it could be a positive sign for future performance of EMC stock that the shares held firmly on generally disappointing news. This is often a sign that expectations have been lowered to a beatable level and that sellers of the stock are done. In other words, EMC shares may be in strong hands with better news to come and expectations low.

I do not want to get bogged down in recapping the numbers from QCOM and EMC, so let’s focus on the big picture. Northlake’s long-term approach to individual stocks emphasizes big picture themes, similar to thematic approach used by Northlake’s Market Cap and Style models.

QCOM’s results show the company’s leading position as the most important semiconductor supplier to smartphone industry. There was worry that Apple’s recent market share losses and cautious guidance for the March quarter would negatively impact QCOM. Apple could be as much as 15-20% of QCOM’s business. However, the beauty of QCOM is that it is a critical supplier to all of the major smartphone companies, including Samsung, the current market share leader. QCOM is also expanding its addressable market with products for all mobile devices including tablets and possibly laptops and ultrabooks in the near future. The investment thesis for QCOM is simple: riding the wave of smartphone adoption and mobile internet all over the world. High end, low end, emerging markets, industrialized markets. For QCOM, its does not matter. Think Intel back in the halcyon days of the PC adoption cycle. I think the stock can reach $80 this year, up more than 20% from Friday’s close.

EMC is a little trickier. Frankly, the stock has been disappointing, trading at about the same level as when it was initially purchased for Northlake clients in the fall of 2011. EMC has a similarly strong secular growth story to QCOM as it provides products to manage the massively growing storage needs driven by the internet revolution. Cloud computing, big data, virtualization…EMC is the leader in many next generation trends. The problem for the stock has been that the bulk of the company’s revenues come from large enterprises and governments. These purchasers have been under a lot of pressure to control budgets in a slow growth economic environment amid large Federal and State budget deficits.

EMC management has done a good job and the company has been growing. Growth has lagged Wall Street estimates, however, placing a stiff headwind on the shares. I am encouraged by the action in the shares since the company reported. It is consistent with a bottoming pattern often seen in stocks. EMC’s valuation is cheap and it is not a stretch at all to see the stock return to the $30 level in 2013. I am keeping EMC on a short leash but my current position is to hold on for one more quarter expecting that guidance will have proven conservative and expectations are low setting up a positive surprise and renewed enthusiasm for the shares.

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

Qualcomm Story Kicking In Big Time

Qualcomm (QCOM) bucked the trend of negative earnings and lowered guidance that has been prevalent in technology stocks this quarter. The company reported a good old fashioned “beat and raise” quarter. The shares are responding very well, up 4% in a down market.

I like QCOM because it is the Intel of smartphones. Much as Intel chips powered the PC revolution of the 1990s, QCOM chips and technology is powering the smartphone revolution of today. In its most recent quarter, QCOM saw better than expected demand and profit margins as it appears to have overcome supply constraints first encountered earlier this year. Even more bullish, the company forecast much better than expected demand for the December quarter and fiscal year 2013. Guidance for those periods is way ahead of analyst expectations.

For some time, I have been waiting for the proverbial tipping point when smartphone sales would trigger a breakout in QCOM’s financial results. It appears the breakout is finally happening. The elimination of supply constraints is coinciding with surging smartphone demand at the high end (new phones from Apple and Samsung) and low end (cheaper smartphones enabling emerging market subscribers to finally upgrade). This tipping point is occurring when investors are nervous, so the positive flow through to the shares is more pronounced.

The multiyear outlook for smartphone demand is excellent. Global subscribers with smartphones should more than double in the next several years. QCOM has a long runway of growth ahead. A move in the shares to $75-80 in 2013 is well within the realm of possibility.

Qualcomm is widely held by Northlake Capital Management LLC, including in Steve Birenberg's personal accounts. Steve is sole proprietor of Northlake, a long only registered investment adviser. Qualcomm is a net long position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, entertainment, leisure, communications and related technologies. Steve Birenberg is co-portfolio manager of Entermedia, owns a stake in the funds' investment management company and has personal monies invested in the funds

Earnings from Google, Qualcomm, and EMC Greeted Warmly

The early part of each quarterly earnings season is focused on technology companies as far as Northlake Capital Management’s strategies are concerned. Thus far, we have heard from Google (GOOG), Qualcomm (QCOM), and EMC Corporation (EMC). All three stocks reacted well to their earnings announcement, recovering a significant portion of recent share price declines. Heading into this earnings period, technology stocks sold off sharply on concerns about demand given weaker economic data around the globe. Foreign exchange was also a big worry. Technology companies are global as the language and use of technology crosses borders with ease. Furthermore, mega trends toward mobile broadband, smartphones, and big data are global.

GOOG, QCOM, and EMC each reported results that were very close to expectations. Wall Street was prepared for much worse. Guidance commentary was similar. QCOM guided lower although not as bad as feared. GOOG does not provide guidance but comments on business trends indicate no deceleration beyond the impact of foreign exchange. EMC reaffirmed its guidance, confirming the power of data storage trends. In the short-term, stocks react to news based on expectations. Expectations were low for GOOG, QCOM, and EMC due to macroeconomic fears. As it turned out, good operating execution and powerful long-term business trends allowed each company to beat the lowered expectations. In turn, the stocks rallied sharply. Let’s take a brief, closer look at each company.

The major takeaway from GOOG is that investors are growing more comfortable with the transition to mobile search. The big controversy in 2012 has been the balance between much lower average prices for search advertisements and much higher volume of searches. Both factors are due to the shift toward mobile computing. Additional influences are more searches in lower priced emerging markets, changes to Google’s ad serving technology, and foreign exchange. In the most quarter, the number of paid searches rose by 42%, while the average price per paid search advertisement fell 16%. In prior quarters, this sort of mix was greeted rudely by investors despite the company continuing to produce 20-25% revenue growth. This quarter the street reacted positively to the results. I think GOOG shares reached a positive tipping point with this quarterly report. The stock remains about % lower in 2012 and has plenty of room to make up.

QCOM actually slightly missed earnings and revenue estimates and issued guidance below current street estimates for the September quarter. Normally, this would have punished the stock. However, expectations were for even worse results and guidance. The stock had already fallen from the upper $60s in April, reflecting a summer slowdown in smartphone sales ahead of the iPhone 5 introduction this fall and supply constraints that leave QCOM short of inventory to meet current demand. The quarter proved to be a relief after a string of bad news. All of this is timing related. QCOM remains perfectly positioned to play the mobile broadband trend by providing the key semiconductor technology for smartphones and tablets. Relief and improved sentiment is a welcome change after a few tough months. I do not think the near-term is as bullish for QCOM as GOOG but beyond the next few months the investment thesis remains very good.

EMC preannounced its June quarter earnings and maintained full year guidance. The stock had pulled back from $30 to $23 since April as macroeconomic worries built and many other enterprise-focused technology companies reported shortfalls or cut guidance. I was remained confident in EMC for a couple of reasons. First, the trend toward management of data is as important as the trend toward broadband internet. Cloud computing is raising the demand for hardware and software solutions as requirements for data retrieval and management grow rapidly. This trend supports EMC’s business fundamentals even against the grain of a tough macroeconomic environment. Second, EMC announced upgraded products across most its product line in the spring. This was always part of the business plan but analysts apparently missed the positive impact. When the industry leader offers new products into a market with heavy demand the results can come quickly. This is the case at EMC and the upgrade cycle is protecting the company’s revenues against the deceleration in global economic growth. EMC is a boring stock compared to GOOG and QCOM but the long-term outlook is equally strong as “big data” and cloud computing are powerful and irreversible technology trends.

Disclosure: Google, Qualcomm, and EMC are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, an Illinois-registered investment advisor. Filings can be found at www.sec.gov. Google and Qualcomm are net long positions in the Entermedia Funds. The Entermedia Funds are long/short equity hedge funds focused on media, entertainment, communications, and related technologies. Steve Birenberg is co-portfolio manager of Entermedia, owns a stake in Entermedia’s investment management company, and has personal monies invested in the Funds.