Wireless chipmaker Qualcomm (NASDAQ:QCOM) missed analysts' expectations in Q3 FY2023, with revenue down 22.7% year on year to $8.45 billion. Qualcomm made a GAAP profit of $1.8 billion, down from its profit of $3.73 billion in the same quarter last year.
Qualcomm (QCOM) Q3 FY2023 Highlights:
- Revenue: $8.45 billion vs analyst estimates of $8.51 billion (0.66% miss)
- EPS (non-GAAP): $1.87 vs analyst estimates of $1.81 (3.35% beat)
- Revenue Guidance for Q4 2023 is $8.5 billion at the midpoint, below analyst estimates of $8.74 billion
- Free Cash Flow was -$639 million, down from $1 billion in the previous quarter
- Inventory Days Outstanding: 159, up from 150 in the previous quarter
- Gross Margin (GAAP): 55.1%, down from 56% in the same quarter last year
Having been at the forefront of developing the standards for cellular connectivity for over four decades, Qualcomm (NASDAQ:QCOM) is a leading innovator and a fabless manufacturer of wireless technology chips used in smartphones, autos and internet of things appliances.
Qualcomm has one of the more unique semiconductor business models. Its research has created the intellectual property that is the foundation for the global wireless industry. In the 1990s they developed the original code division multiple access (CDMA) technology that became the standard for cell phone networks first in the US, then around the world. Qualcomm has had a hand in developing Wi-Fi, GPS, and Bluetooth, along with RFID (Radio Frequency ID), and 4G and 5G technology.
It monetizes its portfolio of more than 140,000 patents through designing semiconductors used in handsets, autos, and IoT and also through licensing its patents for others to incorporate in their own products. Qualcomm outsources manufacturing of its chips, its main product family is the Snapdragon chip, an all in one chip used to power mobile devices: it includes a cellular modem, integrated Wi-Fi, Bluetooth, and GPS, along with a CPU (central processing unit) and GPU (graphics processing unit). Different versions of Snapdragon are used in different types of devices (tablets, laptops, handsets) based on the different battery life or processing requirements.
Qualcomm’s stranglehold on wireless’s foundational technology has enmeshed it in disputes over royalty payments, which are highly consequential to Qualcomm’s business model as it receives a royalty of roughly 5% of the average price of every smartphone sold, and those licensing revenues are nearly pure profit. In 2017, Apple refused to continue paying the royalty which degenerated into a lawsuit with Apple switching to Intel modem chips, only to return to Qualcomm in 2019, when Intel decided not to make 5G modems. Qualcomm also ran into similar disputes with Chinese handset makers such as Huawei in the past few years, all of which have since been resolved, with Qualcomm continuing to receive its royalty payments. Because of its unique position in the semiconductor world, Qualcomm became a geopolitical football during China-US trade tensions over the past few years: China blocked Qualcomm’s attempted acquisition of NXPI over antitrust concerns, while the US blocked Broadcom proposed hostile takeover of Qualcomm over national security concerns.Qualcomms peers and competitors include AMD (NASDAQ:AMD), Broadcom (NASDAQ:AVGO), Intel (NASDAQ:INTC), MediaTek (TWSE:2454), NXP Semiconductors NV (NASDAQ:NXPI), Nvidia (NASDAQ: NVDA), and Samsung (KOSI:005930).
Processors and Graphics Chips
Chips need to keep getting smaller in order to advance on Moore’s law, and that is proving increasingly more complicated and expensive to achieve with time. That has caused most digital chip makers to become “fabless” designers, rather than manufacturers, instead relying on contracted foundries like TSMC to manufacture their designs. This has benefitted the digital chip makers’ free cash flow margins, as exiting the manufacturing business has removed large cash expenses from their business models.
Qualcomm's revenue growth over the last three years has been strong, averaging 28.5% annually. But as you can see below, its revenue declined from $10.9 billion in the same quarter last year to $8.45 billion. Semiconductors are a cyclical industry, and long-term investors should be prepared for periods of high growth followed by periods of revenue contractions (which can sometimes offer opportune times to buy).
Qualcomm had a difficult quarter as revenue dropped 22.7% year on year, missing analysts' estimates by 0.66%. This could mean that the current downcycle is deepening.
Qualcomm's revenue growth has decelerated over the last three quarters and its management team projects growth to turn negative next quarter. As such, the company is guiding for a 25.4% year-on-year revenue decline while analysts are expecting a 0.69% drop over the next 12 months.
Product Demand & Outstanding Inventory
Days Inventory Outstanding (DIO) is an important metric for chipmakers, as it reflects a business' capital intensity and the cyclical nature of semiconductor supply and demand. In a tight supply environment, inventories tend to be stable, allowing chipmakers to exert pricing power. Steadily increasing DIO can be a warning sign that demand is weak, and if inventories continue to rise, the company may have to downsize production.
This quarter, Qualcomm's DIO came in at 159, which is 69 days above its five-year average, suggesting that the company's inventory has grown to higher levels than we've seen in the past.
In the semiconductor industry, a company's gross profit margin is a critical metric to track because it sheds light on its pricing power, complexity of products, and ability to procure raw materials, equipment, and labor. Qualcomm's gross profit margin, which shows how much money the company gets to keep after paying key materials, input, and manufacturing costs, came in at 55.1% in Q3, down 0.8 percentage points year on year.
Despite declining over the last 12 months, Qualcomm still retains reasonably high gross margins, averaging 56.2%. These margins point to its solid competitive offering, disciplined cost controls, and lack of significant pricing pressure.
Qualcomm reported an operating margin of 29.8% in Q3, down 6.8 percentage points year on year. Operating margins are one of the best measures of profitability because they tell us how much money a company takes home after manufacturing its products, marketing and selling them, and, importantly, keeping them relevant through research and development.
Qualcomm's operating margins have been trending down over the last year, averaging 36.6%. However, the company's profitability remains one of the strongest in the industry, driven by its solid gross margins and economies of scale generated from its highly efficient operating model.
Earnings, Cash & Competitive Moat
Wall Street expects earnings per share to decline 9.55% over the next 12 months, although estimates will likely change after earnings.
Although earnings are important, we believe cash is king because you can't use accounting profits to pay the bills. Qualcomm's free cash flow came in at -$639 million in Q3, down 127% year on year.
As you can see above, Qualcomm produced free cash flow of just $3.87 billion in the last year, resulting in a measly 9.72% free cash flow margin. Qualcomm will need to improve its free cash flow conversion if it wants to stay competitive.
Qualcomm's average return on invested capital (ROIC) of 78.9% over the last five years implies that it has a strong competitive position and was able to invest in profitable growth over time.
Key Takeaways from Qualcomm's Q3 Results
With a market capitalization of $147 billion, a $8.63 billion cash balance, and positive free cash flow over the last 12 months, we're confident that Qualcomm has the resources needed to pursue a high-growth business strategy.
It was good to see Qualcomm beat analysts' earnings expectations this quarter. That really stood out as a positive in these results. On the other hand, its revenue guidance for next quarter was underwhelming and its operating margin declined. Overall, this was a mixed quarter for Qualcomm. The company is down 3.32% on the results and currently trades at $125.03 per share.
Is Now The Time?
Qualcomm may have had a bad quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity. We think Qualcomm is a solid business. We'd expect growth rates to moderate from here, but its impressive revenue growth suggests that it's expanding its market share over the last three years. And while its cash burn raises the question of whether it can sustainably maintain its growth, the good news is its high ROIC suggests it is well run and in a strong position for profitable growth and its strong operating margins are indicative of a well-run business.
Qualcomm's price-to-earnings ratio based on the next 12 months is 14.6x. There are definitely things to like about Qualcomm and looking at the semiconductors landscape right now, it seems that the company trades at a pretty interesting price point.
Wall Street analysts covering the company had a one year price target of $137.3 per share right before these results, implying that they saw upside in buying Qualcomm even in the short term.
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