Trade War Could Bring Qualcomm Revenue to 7-Year Low

Qualcomm stock (QCOM) is taking a hit from the renewed trade war tensions as other semiconductor stocks continue to struggle. Yesterday was a weak day for semiconductor stocks with exposure to the communications market. Apple and Samsung suppliers’ stocks fell between 2.5% and 4.5%. But Qualcomm took the biggest hit. The stock fell 2.2% in the normal trading on July 31 and as much as 6% after-hours as it reported weak fiscal 2019 third-quarter earnings and guidance.

The company expects its fiscal 2019 revenue to fall to a seven-year low. The weak guidance is due to the US-China trade war’s multifold impact on Qualcomm.

Trade War Could Bring Qualcomm Revenue to 7-Year Low

The US ban on Huawei encouraged the handset maker to reduce its reliance on US companies like Qualcomm. Moreover, Huawei accelerated its efforts in the Chinese market, which made the firm a more pronounced competitor of Qualcomm’s in China. Qualcomm earns 65% of its revenue from China and more than 10% from Huawei. Soaring competition from Huawei and restricted trade to Chinese OEMs (original equipment manufacturers) hurt Qualcomm’s earnings.

Qualcomm has more worries lined up

Adding to the trade tensions, the global smartphone shipments fell 2.3% YoY (year-over-year) in the second quarter, according to IDC data. Qualcomm also faced a fine of $275 million from the European Union for anti-competitive practices. The FTC ruled against Qualcomm’s licensing practices in May.

All these factors are pressuring Qualcomm’s earnings. But amid these headwinds, 5G opportunities are a silver lining. Qualcomm CEO Steve Mollenkopf stated that handset makers are transitioning from 4G to 5G, which is reducing 4G demand. At the same time, Qualcomm’s 5G design wins doubled last quarter, and it will start driving its earnings in the first quarter of calendar 2020. This brings us to the question of how will Qualcomm survive the next six months. The answer lies in its fundamentals.

Trade War Could Bring Qualcomm Revenue to 7-Year Low

Qualcomm’s revenue missed analysts’ estimates on trade war tensions 

Qualcomm’s fiscal 2019 third-quarter earnings include a one-time payment from its largest customer Apple (AAPL) as part of a legal settlement of a two-year-long licensing dispute. During the quarter, the chip supplier’s revenue rose 73% YoY to $9.6 billion, of which $4.7 billion came from the Apple settlement. However, for our analysis, we’ll consider earnings after adjusting for the Apple payment.

Qualcomm’s adjusted revenue fell 13% YoY to $4.9 billion, missing analysts’ estimate of $5.1 million. The company earns revenue by selling modem chips and mobile processors and even licensing 4G/5G technology to smartphone OEMs. It’s also leveraging its technology in adjacent markets like laptops and wearables. Qualcomm’s revenue fell as its revenue from chipset fell 13%. Revenue from the licensing business fell 10% YoY.

Trade War Could Bring Qualcomm Revenue to 7-Year Low

Qualcomm’s chipset business hit by the China trade war

Qualcomm’s chipset business saw MSM (Mobile Station Modem) shipments fall 22% YoY to 156 million in the third quarter of fiscal 2019. Trade restrictions on China encouraged some of Qualcomm’s Chinese customers to switch to domestic suppliers. Moreover, these customers lost some share in China’s smartphone market to Huawei. Qualcomm expects this trend to continue in the September 2019 quarter. It therefore expects MSM shipments to fall 35% YoY to 150 million in the fourth quarter of fiscal 2019.

4G to 5G transition hurts Qualcomm’s licensing business 

Qualcomm’s licensing revenue rose 15% sequentially to $1.29 billion in the third quarter of fiscal 2019. The revenue included royalties from Apple and its contract manufacturers for the iPhones sold in the June 2019 quarter. It also included the last batch of a three-part payment of $150 million each in an interim settlement with Huawei. Qualcomm and Huawei haven’t reached a settlement over their licensing dispute. They’re unlikely to reach one until the trade war eases.

YoY, licensing revenue fell 10% because Qualdomm’s Chinese customers canceled their upcoming 4G smartphones to focus on 5G. This trend will be more prominent in the second half, when most companies launch their new smartphone models. Qualcomm lowered its 3G/4G/5G device shipment estimate for calendar 2019 by 100 million units to 1.75 billion units.

Trade War Could Bring Qualcomm Revenue to 7-Year Low

Qualcomm’s profits continue to fall

Qualcomm’s falling revenue reduced its non-GAAP EPS by 20% YoY to $0.80 in the third quarter of fiscal 2019. The EPS met analysts’ estimate of $0.80. During the quarter, the company paid a fine of $275 million to the European Union and incurred a tax expense of $2.01 per share. These one-off expenses mitigated the $3.23 EPS it earned from Apple’s one-time settlement payment. Its one-off transactions are reported in GAAP results.

Trade War Could Bring Qualcomm Revenue to 7-Year Low

Qualcomm expects fiscal 2019 fourth-quarter revenue to fall to a seven-year low

The second half will be challenging for Qualcomm due to smartphone demand weakness, trade restrictions on China, and transition from 4G to 5G. The company expects its fiscal 2019 fourth-quarter revenue to fall 19% YoY and 4.1% sequentially to a seven-year low of $4.7 billion. This guidance missed analysts’ estimate of over $5.6 billion. Qualcomm stated that the guidance excludes $150 million licensing payment from Huawei. Its expects fiscal 2019 fourth-quarter non-GAAP EPS to fall to $0.7.

The above guidance implies that Qualcomm’s fiscal 2019 revenue will fall by 15%, or $3.3 billion from the previous year, to $19.4 billion. The last time Qualcomm reported revenue below $20 billion was in fiscal 2012. The above guidance shows that it’s fiscal 2019 non-GAAP EPS would reach $3.47, missing its target of $5.25 it promised shareholders to avoid a hostile takeover by Broadcom in February 2018.

Qualcomm’s stock price movement

Qualcomm stock has faced some ups and downs in 2019 because of legal issues with Apple and exposure to China and Huawei. More headwinds than tailwinds saw the chip supplier’s stock underperform the semiconductor industry but outperform the S&P 500 Index. Qualcomm’s stock rose 27.4% year-to-date. Meanwhile, the VanEck Vectors Semiconductor ETF (SMH) and the SPDR S&P 500 ETF Trust (SPY) rose 33% and 18.9%.

Qualcomm is banking on the 5G rollout to boost revenue. But the trade war is preventing the company from taking advantage of the biggest 5G market—China. The uncertain environment is part and parcel of Qualcomm’s business. Management is used to dealing with headwinds and still delivering positive earnings and shareholder returns. It’s a good stock for dividend-seeking investors but a risky bet for traders.