Event: Qualcomm (QCOM) reports fiscal Q3 results tonight after the close. The options market is implying a 4.5% one day post earnings move which is shy of the 7% average over the last 4 quarters and the 5.1% 10 year average one day post earnings move. The stock has declined the day following the last 9 earnings reports.
Following Monday’s $32 billion acquisition of ARM Holdings by Japan’s Softbank, I had some thoughts on QCOM’s current positioning in the semiconductor space (MorningWord 7/18/16: QCOM – ARM Wrestled):
QCOM is still too reliant on mobile devices and will need to pivot part of their company fast like INTC. To do that, QCOM will need to get into the IoT acquisition game. The short list includes Silicon Labs (SLAB), Microchip (MCHP) or NXP (NXPI).
QCOM sports a cash balance of $30 billion vs their market cap of $80 billion, net of their $12 billion in debt. That’s a whopping 22.5% of their market cap in cash. QCOM trades at a discount to the S&P 500 (SPX) at 13.4x expected 2016 eps, a discount to most peers including INTC. The only thing they have been interested in buying of late is their stock (the company launched a$10 billion accelerated share repurchase last May) at the behest of activist shareholders. Considering sales are only expected to be down 5% year over year, I suspect a strategic acquisition would be met with greater enthusiasm by QCOM investors than their March 2015 commitment to returning 75% of free cash flow to stockholders. The stock is down 25% since that proclamation.
Price Action / Techncials: QCOM has mildly under-performed the Semiconductor Index (SOX) ytd, up 10.5% vs 12%, despite its 30% rally off of its multi-year lows made in February. On Monday’s Fast Money program on CNBC my friend Carter Worth of Cornerstone Research made a fairly bullish case for an upcoming breakout in the stock, watch here:
Carter is eyeing a gap fill from the stock’s decline following their disappointing fQ4 results in early November 2015. That’s a logical move if the stock can breakout above near term technical resistance at $56.50:[caption id="attachment_65145" align="aligncenter" width="600"] QCOM 1yr chart from Bloomberg[/caption]
I’d add that there is obvious technical support at $50, and given the stock’s recent rally, that is exactly where it is going in the event of a material guide down.
Wall Street analysts remain fairly mixed on the stock with 14 Buy ratings, 16 Hold ratings and 2 Sells. On Friday, BMO Capital Markets analyst Tim Long cut his rating from Buy to Sell, per Barron’s Tech Trader Daily:
He writes that although the company’s dividend and cash flow yields are providing support at the moment for the stock, he’s concerned about negative catalysts on the horizon.
First, he expects a “meaningful” guide down for the September quarter, concentrated in Qualcomm’s licensing business. (He’s 10 cents below consensus for September quarter EPS.) He also believes that management guidance for 3G/4G unit growth this year is too aggressive at 5-11%–he estimates 2%. Finally, he believes expects more chip market share losses in fiscal 2017, and argues that Intel’s (INTC) win at Apple (AAPL) and Mediatek’s potential entry into Samsung (005930KS) could hurt margins.
Our EPS estimate of $0.99 for September is below consensus of $1.09, and our EPS estimate of $4.44 for FY 2017 is below consensus of $4.67. We expect the stock to pull back as estimates are lowered, while more tangible signs of share losses could pressure the multiple. There is good valuation support, with a 3.9% dividend yield and a 10% free cash flow yield, track the peer group.
My Take: The stock is cheap, great balance sheet, massive commitment to capital return with a 3.85% dividend yield amidst pretty negative investor sentiment. A beat and raise and the stock is easily $60 and higher in the weeks to come, especially if they were to use some of that $31 billion in cash to diversify with a IoT acquisition that is NOT 20x sales. M&A action could send the stock higher if they were disciplined. For instance if they could manage to pay close to $2.5 to $3 billion for SLAB which would be about 5x sales.
On the flip side, fear of a guide down is in the market, and the stock has risen in the face of it. I am hard-pressed to see how the stock holds or goes higher on the type of downgrade to guidance to the that BMO expects. But at that point investors will also be looking for some sort of an inflection for an earnings trough.
Therefore defined risk longs make sense for those looking to get in after this run. If the bounce off the lows continues the stock is likely to see 60 or so in the near future. If this has been a headfake and earnings are the catalyst for a revisit of recent lows, you’ll want to know what you can lose.
So What’s the Trade?
If you were inclined to buy the breakout, playing for a post earnings gap fill you might consider a defined risk strategy that targets a gap fill back to $60:
Buy the QCOM ($55.40) August 55.50/60 call spread for $1.35
- Buy 1 August 55.50 call for 1.50
- Sell 1 August 60 calls at .15
Rationale – This trade defines risk to just 1.35 if the stock were to decline precipitously following the event. That’s less than 2.5% of the underlying stock price. And much less than the 4.5% implied move. And especially disciplined considering the 7% average decline after the last 4 earnings. The break-even on this trade is $56.85 and it has a max gain of 3.15 if the stock is at or near 60 on August expiration.
If you thought the company could miss and guide down then a put spread targeting the recent lows make sense. This also makes for a decent hedge.
Buy the QCOM ($55.40) August 55/51 put spread for $1
- Buy 1 August 55 put for 1.38
- Sell 1 August 51 puts at .38
Rationale – This trade defines risk to $1, or less than 2% of the stock price. while offering potential gains of 3x that at risk. The trade breaks-even at $54, down 2.5%, less than the implied move with max gain of $3 at $51 or lower.
Estimates & Forecasts From Bloomberg:
-3Q adj EPS est. 97c (range 93c-$1.02); co. forecast 90c-$1.00 (April 20)
-3Q rev. est. $5.59b (range $5.45b-$5.74b), co. forecast $5.2b-$6b (April 20)
-3Q gross margin est. 60% (range 59%-61.4%)
-4Q adj. EPS est. $1.08 (range 97c-$1.22)
-4Q rev. est. $5.72b (range $5.46b-$6.09b)
NOTE: QCOM also forecast FY16 QTL rev. of $7.3b-$8b and calendar 2016 global 3G/4G device shipments of 1.625b