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Did Investors Overreact to Qualcomm's Coronavirus Warning?

By Leo Sun – Updated Feb 12, 2020 at 12:52PM

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The chipmaker reduced the lower end of its second-quarter guidance in response to the virus outbreak in China.

Qualcomm (QCOM -1.62%) recently posted first-quarter numbers that beat Wall Street's expectations. The chipmaker's revenue rose 5% annually to $5.08 billion, topping estimates by $250 million. Its non-GAAP earnings fell 18% to $0.99 per share, but still cleared expectations by $0.14.

Qualcomm expects its second-quarter revenue to rise 2%-19% annually, and for its non-GAAP EPS to decline 21%-33%. The midpoint of those estimates surpassed analysts' expectations for 6% revenue growth and a 29% decline in earnings.

However, Qualcomm also widened the range of its EPS guidance to account for the novel coronavirus outbreak in China. Instead of a typical $0.10 range for its guidance, Qualcomm widened the lower end of its second-quarter guidance by a nickel, from $0.85-$0.95 to $0.80-$0.95.

That adjustment was minor, but management's comments regarding COVID-19 (the proper name for what many call the coronavirus) during the conference call raised red flags and triggered a sell-off. Let's look back at those comments and see if investors overreacted to the chipmaker's warnings.

A positive coronavirus blood test.

Image source: Getty Images.

What did Qualcomm say about COVID-19?

CEO Steve Mollenkopf called the COVID-19 outbreak an "unprecedented situation" during the call, and CFO Akash Palkhiwala warned of "significant uncertainty" regarding the new virus's impact on the smartphone supply chain and consumer demand.

Palkhiwala stated that the $0.05 reduction to the bottom end of the company's second-quarter guidance reflected the information Qualcomm had "at this point," and that it would "continue to monitor" the situation.

In the accompanying 10-Q filing, Qualcomm warned that the COVID-19 outbreak could throttle the production capabilities of its suppliers with quarantines and closures, reduce consumer demand, and "negatively impact" its business and operations.

Another headache in China

Qualcomm already faces major challenges in China. Its QCT (chipmaking) business, which generates most of its revenue, faces competition from first-party chipmakers like Huawei.

A Chinese flag on a printed circuit board.

Image source: Getty Images.

Its QTL (licensing) business, which generates most of its profits with high-margin licensing fees, is also struggling to strike a new licensing deal with Huawei. Huawei, which claims that Qualcomm's fees are too high, stopped paying per-device licensing fees last year, and only agreed to interim payments of $150 million per quarter.

Qualcomm also warned that its licensing agreements with other Chinese OEMs, which were signed over the past five years, are only effective for a "specified term" -- which suggests that other handset makers could eventually join Huawei's rebellion.

The trade war between the U.S. and China also forced major OEMs like Huawei to develop new smartphones that don't use any American components. Huawei's Mate 30, for example, uses a mobile SoC and baseband modem from its own subsidiary HiSilicon instead of Qualcomm. The Chinese government is also actively sponsoring the development of domestic chips, which could eventually threaten Qualcomm's sales of mobile chipsets and baseband modems.

Qualcomm's total revenue from China plunged 23% annually to $11.6 billion in 2019, but still accounted for 48% of its top line. In short, the chipmaker already faces significant challenges in the country, and COVID-19 could exacerbate that pain by disrupting its supply chain and throttling handset sales across the country.

Did investors overreact to Qualcomm's warning?

Qualcomm's stock rallied nearly 80% over the past 12 months, so it wasn't surprising to see some investors take profits as storm clouds gathered. Qualcomm's guidance adjustment was minor, but its comments about COVID-19 suggest that uglier reductions could be right around the corner.

As a result, it's tough to tell if analysts' forecasts for 16% revenue growth and 20% earnings growth this year are still valid. If they are, Qualcomm's stock still looks cheap at 14 times forward earnings.

I don't think Qualcomm's investors should panic and sell their shares yet. However, investors should closely monitor the COVID-19 epidemic and Qualcomm's shifting challenges in China. If those headwinds wane, it could signal a good time to accumulate Qualcomm's shares at a discount to its earnings growth.

Leo Sun has no position in any of the stocks mentioned. The Motley Fool owns shares of Qualcomm. The Motley Fool has a disclosure policy.

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