The company offers a 3.4% yield, has increased its dividend every year since 2003, and has recorded annual dividend growth in excess of 20% over the last five years.
Furthermore, Qualcomm’s stock is down roughly 25% from its 2014 highs and trades around 16.5x 2016 estimated earnings.
These are the types of characteristics we like to see for investments in our Top 20 Dividend Stocks portfolio.
However, with technology trends changing more rapidly and becoming harder to identify, should Qualcomm make the cut?
QUALCOMM, Inc – Business Analysis
Qualcomm is a leader in the development and commercialization of digital communication technologies called CDMA (Code Division Multiple Access) and OFDMA (Orthogonal Frequency Division Multiple Access), including LTE (Long Term Evolution).
They own significant intellectual property applicable to products that implement any version of CDMA and OFDMA, including patents, patent applications and trade secrets.
Any companies in the mobile communications industry trying to develop, manufacture, and/or sell products using CDMA and/or LTE standards requires a patent license from Qualcomm.
They also develop other technologies used in handsets and tablets including certain audio and video technologies, advanced WLAN functionality, and memory controllers.
In addition to the licensing areas of their intellectual property portfolio, they design and manufacture products and services based on CDMA, OFDMA, and other digital communications technologies.
Their products mainly consist of chips and system software used in mobile devices and in wireless networks. To a lesser extent they sell integrated circuits for use in broadband gateway equipment, desktop computers, and streaming media players.
The main factor that drives the company’s performance is cell phone penetration, particularly with smartphones.
According to World Cellular Information Service (WCIS), the less than 60 million global mobile connections in 1994 grew to approximately 7.2 billion in September 2015.
One of the other key drivers of growth within mobile is the continued global penetration of 3G/4G technology (CDMA-based, OFDMA- based and CDMA/OFDMA multimode).
In September 2015, this represented 3.4 billion connections, or nearly 47% of total mobile connections, and by 2019 it is projected to reach 5.8 billion.
It is clear that global smartphone penetration continues to grow at a rapid pace. According to Gartner, in 2014 more than 1.2 billion smartphones were shipped and it is projected to increase rapidly with cumulative shipments of smartphones projected to be over 8.5 billion from 2015-2019.
Overall, Qualcomm is primed to ride some secular growth trends for years to come.
Qualcomm operates the business through two main reporting segments: QCT (Qualcomm CDMA Technologies; 68% of revenue) and QLT (Qualcomm Technology Licensing; 32% of revenue).
The QCT segment develops and supplies integrated circuits and system software based on CDMA, OFDMA, and some other technologies for use in voice and data communications along with other technology applications.
The integrated circuits are sold and the software licensed to manufacturers that use their technology in wireless devices (mobile phones, tablets, laptops, etc).
The QTL segment grants licenses to use portions of their intellectual property which includes patents in the manufacturing of wireless products implementing CDMA and LTE standards.
Their licensees manufacture mobile devices, tablets, and laptops along with a whole host of other machine-to-machine devices. The revenue generated in this segment comes mainly from license fees and royalties based on sales by the licensees.
The QTL segment is extremely important for the overall business even though it only contributes about a third of the overall company’s revenue. This is because the licensing business generates extraordinary high margins.
At the segment level, QTL reported a pretax margin of nearly 87% in 2015, which towers over the QCT segment’s pretax margin of about 14% in 2015.
QUALCOMM, Inc – Key Risks
With such a great business benefitting from these strong secular trends and secured by a strong intellectual property portfolio, many investors are wondering why the shares of the company have declined so precipitously.
As noted above, Qualcomm makes most of their profits in the licensing business. However, over the last year or two there have been some negative developments.
The two main issues are declining royalty rates and a weaker intellectual property portfolio for newer wireless technology generations.
Some companies and entities have proposed changes to intellectual property policies with the goal of devaluing Qualcomm’s patents and breaking up its hold on mobile devices.
For instance, in China they reached a resolution with the National Development and Reform Commission (NDRC) where they will charge royalties of 5% for multimode 3G/4G devices but only 3.5% for 4G.
Furthermore, the royalty rates will be based off 65% of the device’s net selling price instead of the full price.
This is a big change in the way Qualcomm has historically generated royalty revenue in China and effectively results in a cut in royalty rates for 3G to 3.25% (5% x 65%) and 4G to 2.275% (3.5% x 65%).
While the percentages might sound small, the differences really add up when applied over millions of units.
Also, many of their key customers have been lobbying standards groups to change their policies away from Qualcomm’s current licensing and royalty structure with the aim of lowering royalty rates.
One of the main contributing factors to the lower rate is that their intellectual property portfolio isn’t as strong in subsequent generations (4G/5G) as it is in 3G.
3G/4G multimode products are generally covered by their existing 3G licensing agreement, but products that implement 4G and not also 3G are not generally covered by these agreements, so their overall royalty rate for 4G is lower than 3G.
These are real issues for the company and given global politics and competitive positions, they are very difficult issues for investors to obtain clarity.
To offset some of these issues management has been executing on a strategic realignment plan that calls for a spending reduction of $1.4 billion. Reducing the cost structure should result in QCT operating margins improving to at least 20% (from 14% in 2015).
Time will tell if internal actions can offset some the negative trends the company faces in the industry, but for now it looks like Qualcomm’s entrenched business might be showing some cracks.
QUALCOMM, Inc – Dividend Safety Analysis: Qualcomm
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. Qualcomm’s dividend and fundamental data charts can all be seen by clicking here.
Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.
Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.
We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their track record has been, and how to use them for your portfolio here.
Qualcomm’s Dividend Safety Score is 95, which indicates that the dividend is extremely safe and actually one of the safest in the entire market. The great score is driven by a reasonable payout ratio, solid cash generation, a healthy balance sheet, and stable returns on invested capital.
Currently, analysts expect EPS to be $3.76 for Fiscal Year 2016, and we expect the company to pay out about $2.02 per share in dividends this fiscal year. This implies a payout ratio of about 54%, which is in line with 2015 levels, but above historical levels.