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Qualcomm, Inc. (QCOM): Increasing Top Line, Declining Bottom Line. Why?

QUALCOMM, Inc. (NASDAQ:QCOM) had a steady second quarter, with revenue surging 24% compared to the same period last year. The full-year guidance by the mobile-chip company was on the average side, which resulted in a pullback from investors. The growth might be slowed a little, but the company still has potential. Let us analyze the possible concerns and how they may potentially affect the stocks.

Increasing top line but declining bottom line. Why?

QUALCOMM, Inc. (QCOM)Revenue in the current quarter increased 24% from the prior year’s $6.1 billion, but net income slid 16% to approximately $1.9 billion. Moving ahead, the company projects that revenue will increase at 28%, but profits are expected to increase 21%.

Profits are growing at a slower rate than revenue because of falling margins. Margins in the company’s QCT segment, or equipment-related business, will be around 17%, compared to 20% historically.

QUALCOMM, Inc. (NASDAQ:QCOM)’s major revenue is expected to come from developing markets where smartphone sales are on the rise. In order to penetrate markets such as China and India, the phones will be sold at lower price points; thus the chips inside will carry lower margins as well.

Other concerns

QUALCOMM, Inc. (NASDAQ:QCOM)’s other business, QTL (the license segment), represents 35% of its revenue with a gross margin of about 85%. It is also facing issues. The company currently earns more royalty from 3G than 4G, which can potentially reduce its revenue from its QTL business as developed markets are transiting from 3G to 4G. The company currently earns a 5% royalty for 3G, but approximately 3.3% for 4G/LTE, which should potentially reduce the company’s revenue in the future.

However, the complete transition from 3G to 4G/LTE should take a couple of years even in the developed markets. Furthermore, since the company is offering the 4G/LTE network now, the need to backward integrate will allow it to offer 3G compatibility. It is also facing troubles in collecting royalties from manufacturers in China and from other service providers, which if not resolved soon will potentially affect company’s profitability.

I believe that the company is nowhere near troubled waters at the moment, as it is well positioned to benefit from the 3G to 4G transition. The only concern as of now is that a few years down the line its revenue and profitability might shrink due to lower royalty collection.

Still going strong

QUALCOMM, Inc. (NASDAQ:QCOM) has a strong balance sheet with its net cash of $17 a share financing a quarter of its current stock price, symbolizing the company’s strong liquidity position. Robust cash can be fruitfully utilized to finance its huge R&D expenses, which until now have kept it ahead of competition. Investors further enjoy a dividend yield of about 2.3% at its current prices.

Qualcomm is currently pushing on its reference design program (QRD). The QRD program enables QUALCOMM, Inc. (NASDAQ:QCOM) to provide hardware templates to OEM’s, which by using their designs can create new handsets in two months time compared to a year or even more previously.

The QRD program is benefiting mainly Chinese vendors. Lately, however, companies such as Samsung and HTC too are considering the program to stand tall in emerging markets, especially for low-end phones. Currently, 90% of the 170 QRD-based devices are from the Chinese market, but as other companies from Brazil, India and Vietnam join the program the company will duly benefit.

A look beyond

Qualcomm has been the market leader in 3G, 4G and LTE chips until now, but soon it will face some competition from NVIDIA Corporation (NASDAQ:NVDA) . NVIDIA, the company known for its graphics processors, will ship its first LTE-integrated mobile processor in phones by the end of this year.

The company is trying to set its footing in the low-end processor market, as until now almost all LTE-enabled smartphones and tablets were high end. The low-price processor might push down the prices of smartphones in the market. I believe that the entry of NVIDIA Corporation (NASDAQ:NVDA) will not affect QUALCOMM, Inc. (NASDAQ:QCOM) in the broader sense as it deals in high-end phones, which NVIDIA Corporation (NASDAQ:NVDA) is not targeting at the moment.

Another entrant in the LTE chip market is Broadcom Corporation (NASDAQ:BRCM) . The company announced a new LTE modem chip in February, which it claims to be 35% smaller than any other LTE chip available in the market. The chip, due to its small size, should consume less energy and should be more economical.

Along with the new LTE chip, Broadcom Corporation (NASDAQ:BRCM) also sells other wireless and near-field communication chips, which enhances its existence in the mobile industry. Broadcom Corporation (NASDAQ:BRCM) is thus the most direct competition for Qualcomm in the market at the moment.

Final words

QUALCOMM, Inc. (NASDAQ:QCOM) has a portfolio of clients like HTC, Apple and Samsung that diversify its source of revenue. The emerging markets offer comparatively lower margins but they are the new source to generate future revenue and profits. The potential to deliver from its QRD program is also increasing.

In all, at a PE of 12.7 times and with EPS growth of 21%, QUALCOMM, Inc. (NASDAQ:QCOM) means value and investors should keep it in mind before making any investment decision.

The article Is This Semiconductor Company in Troubled Waters? originally appeared on Fool.com.

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