Chipmakers Qualcomm (QCOM -0.53%) and Texas Instruments (TXN -0.33%) were once direct competitors in mobile application processors and baseband modems. However, TI phased out its baseband business in 2008 and quit the mobile app processor business four years later to produce embedded chips for connected cars, industrial machines, and other devices. TI also continued to supply IC chips, display drivers, and other components to Apple and other smartphone makers.
In retrospect, TI's exit from mobile chips was a timely move, since the market was subsequently commoditized by lower-end chipmakers like MediaTek. That competition forced Qualcomm to diversify into new markets like connected cameras, drones, and data centers. Although Qualcomm and TI are no longer direct competitors, both chipmakers still represent interesting plays on the non-PC chip market. Let's analyze their strengths and weaknesses, and see which is the better buy for 2016.
Top line growth
Last quarter, Qualcomm's sales fell 19% annually to $5.77 billion. Chipmaking revenues, which accounted for over 71% of that total, fell 22% due to rising competition from MediaTek and Samsung's decision to manufacture its own mobile chips. Patent licensing revenues, which accounted for 28% of Qualcomm's sales, slid 12% due to underreported shipments in China and a new licensing dispute with LG. Analysts expect these headwinds to cause Qualcomm's revenue to fall 11% this year.
Texas Instruments fared better than Qualcomm last quarter. Sales slipped 2.4% annually to $3.19 billion, primarily due to weaker demand in the personal electronics and wireless infrastructure markets. For the full year, 31% of TI's sales came from industrial customers, 30% came from personal electronics, and 15% came from automotive clients. Apple orders accounted for 11% of its sales, enterprise systems brought in 6%, and "other" sales generated 5%. TI has diversified its top line much more effectively than Qualcomm, which still relies heavily on the smartphone and tablet markets. Looking ahead, analysts expect TI's revenue to decline 9% this year.
Bottom line growth
78% of Qualcomm's pre-tax earnings came from its licensing business last quarter. Unfortunately, pre-tax earnings fell 15% due to its ongoing problems in China. New antitrust probes into those fees in South Korea and Taiwan, its second and third largest markets after China, could continue reducing the unit's margins.
Qualcomm's chipmaking margins will also remain under pressure due to competition from cheaper rivals. That pressure already caused the unit's profits to fall 49% last quarter. Looking ahead, many of Qualcomm's newer chips for drones, connected cameras, and Internet of Things devices could also have lower margins than its mobile SoCs. As a result, analysts expect Qualcomm's margins to remain under pressure and its earnings to slide 12% this year.
Texas Instrument's margins are in much better shape. Last quarter, its gross margin hit a record high of 58.5%, thanks to its new 300mm analog production capabilities. Those higher margins helped TI overcome its top-line decline and post 1.3% annual net income growth. Analysts expect those margins to remain strong and boost earnings 2% this year.
The market has already noticed that Qualcomm is a weaker investment than TI. Over the past five years, shares of Qualcomm have fallen about 16%, while shares of TI have surged over 50%. However, past performance is no guarantee of future returns, so we should examine both stocks' valuations to see which is a better buy today.
Qualcomm currently trades at 16 times earnings, making it cheaper than TI's P/E of 19 and the industry average ratio of 18. Looking ahead, Qualcomm has a forward P/E of 10, which is much lower than TI's forward multiple of 17.
Analysts expect Qualcomm's annual earnings to grow 12% over the next five years, which gives it a 5-year PEG ratio of 0.98. TI's annual earnings are expected to rise 10% during that same period, which gives it a PEG ratio of 1.86. Since a PEG ratio under 1 is considered undervalued, Qualcomm looks much cheaper based on its long-term earnings growth potential. Qualcomm also pays a forward annual dividend yield of 4.3%, which is higher than TI's yield of 3%.
So which one is the better buy?
I believe that Texas Instruments is a "safer" chip play than Qualcomm, thanks to its more diversified business and bottom-line growth. However, Qualcomm recently inked new licensing deals in China, entered a new partnership with Samsung, and has won support for its data center and drone expansions. If these moves pay off, the company's top and bottom line pressures might ease. Those catalysts, along with Qualcomm's lower valuations and higher dividend, make it a slightly better pick than TI in my book.