Even though chip manufacturer Qualcomm (QCOM -1.05%) produced solid revenue and profits in fiscal 2022, nervous investors dropped the stock by 40% last year. The company has fallen out of favor on Wall Street as demand for its primary product has declined.
The good news is that industry experts expect a rebound in Qualcomm's end market in late 2023 or 2024. And with the company recently bouncing off its 52-week low, should you entertain buying the stock at current prices? Or with talk of recession in the air, are there darker times ahead?
Qualcomm suffers due to reliance on mobile phone industry
Qualcomm's primary business is manufacturing modems and chipsets for the smartphone industry, which generated 57% of its fiscal 2022 revenue. Unfortunately, a deterioration in the global economy has resulted in a consumer that is less willing to purchase mobile devices. As a result, management said during the fourth-quarter earnings call that they expect 3G, 4G, and 5G 2022 handset volumes to decline in the low double digits compared to 2021's results.
At the same time that demand for smartphones has fallen off a cliff, smartphone manufacturers have a massive stockpile of chips piled up on their shelves. This chip glut resulted from manufacturers' 2021 belief that a shortage of smartphone components was imminent, ultimately resulting in manufacturers ordering more parts than were needed.
Today smartphone manufacturers have reversed course and are in the process of reducing their chip inventory. Unfortunately, inventory reduction means fewer chip and modem orders than expected for the company, negatively impacting Qualcomm's revenue growth, which is why Wall Street abandoned the stock.
During the fourth-quarter 2022 earnings call, management said that manufacturers would take several quarters to work through the inventory drawdown. Accordingly, investors should monitor management's commentary on customers' inventory levels and orders in future earnings calls.
Suppose that management's commentary on the inventory drawdown is accurate; Qualcomm's mobile handset business should rebound in the second half of 2023.
It can survive the mobile industry downturn
As of its fourth-quarter earnings report, the company had $6.4 billion in cash and marketable securities and $13.5 billion in long-term debt that this $131 billion market cap company could quickly pay off if needed.
Investors should look at two metrics to determine whether a company can pay off its debts: the debt-to-earnings before interest, taxes, depreciation, and amortization (EBITDA) ratio, and the interest coverage ratio.
Qualcomm has a debt-to-EBITDA ratio of 0.94, with a number below 1 indicating that the company generates enough operating income to cover its debts and has additional money left over for other purposes.
Its interest ratio is 32.6, which means the company's operating income is 32.6 times the interest paid during the quarter. The higher the interest coverage number, the more the company's financial strength.
This company has excellent odds of surviving a downturn without financial distress or needing to raise additional capital.
Qualcomm is diversifying its business
Qualcomm is in the middle of a transformation. In the company's own words, "We continue to execute our strategy of transforming Qualcomm from a wireless communications company for the mobile industry to a connected processor company for the intelligent edge." In practical terms, the company wants to diversify from mainly being a smartphone chip and modem manufacturer to becoming a leading manufacturer of devices requiring wireless connectivity, high-performance, low-power computing, and on-device artificial intelligence functions, becoming the guts inside various Internet of Things (IoT) devices, including autos.
One significant benefit is that this transition reduces its reliance on Apple (NASDAQ: AAPL), which is essential since, according to a news report from Bloomberg, Apple plans to replace Qualcomm chips in its iPhone by 2024. In addition, other smartphone manufacturers might eventually follow Apple's lead.
IoT made up approximately 16.8% of the company's revenue in the fourth quarter of 2022, with the automotive segment making up 3.7%. Both company segments are rapidly increasing. IoT's fourth-quarter revenue increased 24% year over year to $1.9 billion, while auto's revenue grew 58% to $427 million. The cherry on top is that it has a robust automotive design win pipeline, which expanded to $30 billion in September 2022, an increase of more than two times since November 2021.
Should you buy the stock?
Currently, the company has a price/earnings-to-growth (PEG) ratio of 0.62. Most analysts consider a PEG ratio below 1 as a sign of an undervalued stock. Additionally, its PEG ratio compares favorably to the wireless equipment industry's PEG ratio of 1.65.
Although the stock could continue to sell off in the short term due to the poor macroeconomic environment, many concerns about this company should clear up in six months to a year. Considering that it has a strong diversification strategy that should boost long-term revenue, now is a great time to start dollar-cost averaging into Qualcomm.