Qualcomm FQ4 22 – Opportunity incoming

The long-term scale tips in Qualcomm’s favour.

• A good set of results marred by a difficult outlook for FQ1 & FY 2023 also contained a few medium-term positives which were, as usual, completely ignored by the market which sent the shares down a further 6.8% in after-hours trading.
• This combined with a 2023 PER of 12.3x leads me to think that the optimal buying opportunity is quickly approaching.
• FQ4 2023 revenues / EPS were $11.4bn / $2.54 which were broadly in line with estimates but guidance for the coming quarter was very weak.
• FQ1 23 revenues are expected to be $9.2bn – $10.0bn ($9.6bn) well below forecasts of $12.1bn while non-GAAP EPS of $2.35 is well below forecasts of $3.43.
• This a result of ongoing weakness in the handset market (no surprise) and also of excess inventory of handset chips which now needs to be cleared which has a disproportionately large effect on chip suppliers like Qualcomm.
• This also comes as no surprise as the semiconductor industry is starting to suffer from the hangover of the supercycle party that it has enjoyed for the last few years.
• Part of this party was driven by an inventory build as everyone panicked about being able to procure components during the pandemic which has now subsided (as it always does) and has been plain to see for well over a year (see here).
• Qualcomm is taking a prudent approach to this and is planning for a weak market as well as the inventory correction (fiscal H1 only) to continue for the entire fiscal year and the cautious tone it sounded on the call masked some of the long-term positives.
• These are:
  • First Apple: which has widely been expected to be in a position to design Qualcomm out the iPhone in 2023 and replace its modems with its own designs.
  • This has not happened, and Apple will continue buying Qualcomm chips for the 2023 iPhone albeit through gritted teeth.
  • Designing modems and the front-end circuitry that goes with them is difficult and it is clear that Apple is still far from being able to produce a quality modem of its own.
  • Again, this is not new news to anyone who has been paying attention, as Qualcomm has a long history of designing modems that work better than anyone else’s in the 3G and beyond radio standards.
  • Hence, I think this puts Qualcomm in a better position when it comes to renegotiating its contract with Apple in 2025 which is very likely to wriggle as hard as it can to get out of paying Qualcomm anything at all.
  • If it still needs chips from Qualcomm at that time, then Apple will have much less wriggle room when it comes to negotiations.
  • This news is positive for both medium-term forecasts as well as the long-term outlook as it confirms that the barrier to entry in modem chips remains alive and well.
  • Second, Automotive: where I have long been of the opinion that Qualcomm is pushing against an open door.
  • Qualcomm now has a $30bn pipeline of design wins of which the majority remain connectivity, but it is not this segment that is growing.
  • Of the $11bn that Qualcomm has added in the last 4 months, the vast majority is for Snapdragon Ride which is its ADAS / Autonomous driving solution.
  • This market is dominated by one supplier where the industry has been crying out for a second source which Qualcomm is now providing.
  • Hence, I suspect that this backlog has a lot more growth in it.
  • Third, Windows on Arm: which is taking much longer than expected.
  • Qualcomm acquired Nuvia for $1.4bn to help it produce its own Arm-based architecture so that it can bring its silicon into line with the performance and power consumption characteristics of Apple’s M-series processors.
  • Chips were supposed to sample in 2022 but this clearly has not happened, and devices are now expected in 2024 meaning that the chips should sample in mid-2023.
  • If Qualcomm and Microsoft can finally produce a chip as good as the M-series but supports Windows natively, then this will open up a large new market for Qualcomm at the expense of Intel and AMD.
• As Warren Buffet often says the market is a short-term voting machine but a long-term weighing machine and I think that these positives are pushing the scale in Qualcomm’s long-term favour.
• However, the short-term obsessed market is voting in favour of a sustained decline in earnings which creates an opportunity for anyone willing to look past the current downturn which I admit is likely to be pretty bad given how good it was on the way up.
• Furthermore, there is a significant risk coming from China which remains one of Qualcomm’s biggest markets.
• The ongoing technology war may curtail some of Qualcomm’s ability to ship to Chinese customers which would trigger further short-term estimate cuts and share price downside.
• Qualcomm has been cautious on China in its planning for this fiscal year but I think it is focusing on the Covid Zero impact and is not including being collateral damage as the dispute worsens.
• Taking all of this into account, it looks like revenues will decline by around 11% this fiscal year and EPS by around 27% and is on this basis that I have looked at the valuation.
• Qualcomm is on FQ 2023 EV / revenues of 3.1x and a GAAP EPS PER of 12.3x which makes me feel much more comfortable with what one could argue is quite a high revenue multiple.
• This means that Qualcomm is cheaper than Intel and it has none of its issues which is why this stock is starting to look very interesting.
• MediaTek is a similar story in terms of valuation which also looks very defensive in the semiconductor sector as the downturn unfolds.
• I continue to prefer these two in this environment, but the time has come to have a closer look at Qualcomm in light of taking a 3 to 5-year position.