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QUALCOMM Incorporated (NASDAQ:QCOM) closed at $174.43 on October 12. The stock has returned 32.9% during the last six months, compared to a 21.2% return for the Insider Monkey Billionaire Index and 14.0% for State Street SPDR S&P 500 ETF Trust.
Qualcomm does two different things. It designs the chips inside a great many phones, and it owns patents that make mobile phones work at all. The second business charges a fee to almost anyone selling a handset, whether or not that handset contains a Qualcomm chip.
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The Smaller Business Is the More Profitable One:
Qualcomm reports its two main businesses separately. QCT designs and sells the chips. QTL licenses the patents, and it collects from handset makers regardless of whose chip is inside the phone. The licensing arm earned $881 million last quarter at a 69% margin. The chip business earned $2.19 billion at 26%. Chips bring in most of the profit, and patents keep most of what they charge.
Patent income also holds up better in a weak handset year. The research behind those patents is already done, so almost every royalty dollar drops straight through. That is part of why Qualcomm keeps turning up among the chip stocks billionaires hold in size. The one they hold most of is up 18% since.
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A Few Customers Decide the Revenue:
The chips are where the trouble is. Chip revenue slipped in the most recent quarter, and chip profit fell slightly faster, because a chip business carries its costs whether or not the orders arrive. A small number of handset makers account for most of that revenue, and one of them designs its own chips.
Losing the business in a single phone generation moves revenue in a way no cost programme offsets. The shares still sit roughly a third below their 52-week high even after a strong six months, so the concern has not gone away. That kind of dependence on a few buyers is what separates this from the quality names we think are underpriced.
The Valuation Case:
The stock trades at 19.65 times next year’s expected earnings, on analyst consensus estimates. It is up 13% from the trailing P/E and does not seem like a demanding price for a company earning the margins this one does, and it is not a bargain either. The verdict is that the market is pricing the customer concentration rather than missing it.
One caution on the headline profit. Qualcomm’s reported net margin currently sits above its operating margin, and that gap is a one-off tax benefit rather than anything the business earned. The company left it out of its own non-GAAP figures.
