Qualcomm: A Rare Technology Value Play

As 2022 came to an end, the slide in the semiconductor sector defined the notable market pullback while also discounting sizable adverse industry outcomes.

However, it’s amid situations such as this that potential opportunities emerge. Although there is still downside risk, buying into the chip group can provide decent entry points for a patient investor.

After a 40% plunge last year, Qualcomm (QCOM) is one of the cheapest semiconductor stocks, and a compelling buy, as it unveils new products for the automotive industry.

At the moment, QCOM is marked down for a reason. Post the pandemic demand pull-forward, its largest business of supplying smartphone chips has been weak. Demand for Android devices is especially sluggish in China, and channel inventory is now bloated — needing a couple of quarters to work down. The shares trade at 12x 2023 earnings estimates and 10x next year’s.

Last Monday, Bloomberg reported that Apple (AAPL) will start replacing Qualcomm’s iPhone modem chips with its in-house production as soon as 2024. Credit Suisse notes that Qualcomm’s guidance already reflects the 2024 replacement for the iPhone 16; the iPhone represents around $4 billion in Qualcomm’s chipset revenue. However, CS believes that Apple’s modem development is independent of its licensing agreement with Qualcomm and that Apple will continue to pay licensing fees since the agreements have held up well when challenged in court.

Wells Fargo downgraded QCOM in December to “underperform,” noting the potential $1.25 hit to earnings per share in 2025, derived from the loss of iPhone revenue. The analyst makes valid points about the lack of growth in the smartphone segment, which accounts for 60% of Qualcomm’s revenues.

The concern is that the company will need to rely on the high-end Android user, where the migration to 5G has started to flatten. Wells is also skeptical that the diversification into auto is a big enough opportunity to move the needle.

Wells Fargo’s take may be too glass-half-empty.

Sentiment and positioning on Wall Street for stocks leveraged to handsets could not be much worse, but once a bottom in the industry forms in the first half of 2023, the second half might look much brighter. China is opening its economy quicker than expected post-Covid lockdowns. Plus, the Apple transition is not a done deal and can easily get pushed out due to technological hurdles.

At the Consumer Electronic Show (CES), Qualcomm showcased its Snapdragon Digital Chassis, which is likely to impact growth. The Snapdragon digital cockpit offers a comprehensive digital solution that integrates infotainment with driving systems through SoC architecture for a next-generation experience.

Qualcomm management is targeting autos revenue of $4 billion by 2026, up from $1.4 billion in 2022, primarily driven by the growth of advanced driver-assisted systems and digital cockpit. Using Qualcomm’s forecasts, automotive revenues are expected to grow at a 31% compounded annual growth rate (CAGR) between 2022-26 and an 18% CAGR from 2026-31 to reach $9 billion in 2031.

In 2018, Qualcomm embarked on an enormous stock buyback, retiring almost 25% of the outstanding shares and reconfiguring its balance sheet from net cash of $17 billion to net debt of $10 billion. Buybacks are now far more opportunistic, and Qualcomm pays a hefty 2.5% dividend with plans to increase the payout by 8-12% annually. The company returned ~90% of free cash flow to shareholders last year, split evenly between buybacks and dividends.

Qualcomm is a rare technology value play; a company on the cutting edge of mobile, automotive, AI, and consumer and industrial IoT. With the stock and sector out of favor, the shares are cheap and poised to regain ground once the smartphone market shows signs of a recovery.

The semiconductor group will likely turn well ahead of the reversal in fundamentals, so it’s usually worthwhile to buy on weakness, while the stocks are out of favor.

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