One of Intel's (INTC 0.34%) biggest failures over the past decade was its inability to enter the smartphone market. Much of that failure can be attributed to Qualcomm (QCOM -1.26%), which dominated the market with its Snapdragon chips to become the biggest mobile chip maker in the world.
But today, Intel and Qualcomm are both stuck in a similar rut: Growth in their core businesses has slowed, and their stocks have now become income-generating value plays rather than high-growth ones. Neither chipmaker will likely fade away anytime soon, but is one of these better than the other? Let's examine their core businesses, growth trajectories, and valuations to decide.
How do Intel and Qualcomm make money?
Most of Intel's revenue and operating income comes from its PC and data center chip businesses. Revenue from its Client Computing (PC and mobile) and Data Center units respectively rose 2% and 9% annually last quarter, and together they accounted for 84% of its top line.
Sluggish upgrade cycles and the disruptive effect of smartphones and tablets weighed down sales of PC chips. Data center chip sales also waned because of weaker-than-expected enterprise spending in China. The remainder of Intel's revenue comes from newer businesses like Internet of Things chips, non-volatile memory, programmable chips (from its acquisition of Altera), and security solutions (from its acquisition of McAfee). Operating income at the Client Computing, Data Center, IoT businesses, and Security segments rose year over year last quarter, but the memory and programmable businesses both posted operating losses.
Qualcomm generates most of its revenue from its mobile chipmaking (QCT) business, but most of its pre-tax earnings come from its higher-margin 3G/4G patent licensing (QTL) business, which takes a 3% to 5% cut of the wholesale price of every smartphone shipped worldwide (excluding China). Given rising competition in the mobile chip market, QCT revenue fell 19% annually to $3.34 billion last quarter as operating profit plunged 77% to $170 million. Pressure from regulators and OEMs to lower licensing fees amid plummeting smartphone margins caused revenue at the QTL unit to fall 12% to $2.14 billion and operating profit to slide 14% to $1.86 billion.
Growth expectations and tailwinds
Intel and Qualcomm both face tough headwinds, so sales and earnings growth will likely remain weak for the foreseeable future. Analysts currently expect Intel to post just 3% sales and earnings growth this year. But Qualcomm is expected to fare worse, with an 11% drop in sales and a 12% earnings decline.
Both companies hope that new chips from their core businesses will boost sales. In PC chips, Intel is counting on its next 14nm revision Kaby Lake in late 2016 and the 10nm Cannonlake in 2017 to get its growth back on track. In mobile chips, Qualcomm hopes its new Snapdragon 820 and next-generation 830s will widen its moat against cheaper challengers like MediaTek.
Intel and Qualcomm are both entering new markets to diversify away from PCs and smartphones, respectively. These markets include chips for Internet of Things devices, drones, and connected cars. Intel recently retreated from mobile chips by axing its 4G chipsets, but it also scored a surprising mobile victory by claiming some orders from Qualcomm in the next iPhone. However, Qualcomm has been advancing into data centers with ARM (ARMH) licensed chips. It's unclear if these chips can dent Intel's 99% share of data center chips, but it represents yet another headwind for that core business.
Valuations and dividends
Intel currently trades at 14.5 times earnings, while Qualcomm has a P/E of 17. Both ratios are much lower than the average P/E of 48 for the broad line semiconductor industry. Those numbers indicate that Intel is currently cheaper than Qualcomm based on past earnings.
Still, looking ahead, Intel trades at 13 times earnings while Qualcomm has a lower forward P/E of 12. Analysts expect Intel to grow its annual earnings by 10% over the next five years, which gives it a 5-year PEG ratio of 1.4. Qualcomm is expected to post 11% annual growth during that period, which gives it a lower PEG ratio of 1.2. Neither figure falls below the "undervalued" PEG threshold of 1, but Qualcomm is cheaper relative to its earnings growth potential.
Qualcomm's forward dividend annual yield of 3.9% is also higher than Intel's 3.1% yield. Both companies have plenty of room to raise their dividends -- Intel paid out 39% of its free cash flow as dividends over the past 12 months, while Qualcomm spent 45%.
So, which stock is a better buy?
Intel and Qualcomm will both remain under pressure in the near term, but Qualcomm is a slightly better choice based on its lower forward valuations and higher dividend. Its reputation as the market leader in low-power mobile chips could also make it easier for Qualcomm to expand into new markets (like IoT) than Intel, which is primarily known for more power-hungry PC and data center chips.