Let me be honest.
When I recommended selling Qualcomm (QCOM) out of my Jubak’s Picks portfolio on April 2, I wasn’t imagining anything like yesterday’s earnings debacle.
The stock closed at $67.97 on April 2 and I recommended taking profits because valuation looked stressed considering the number of competitors that were putting pressure on margins in Qualcomm’s smartphone chip business. The stock jumped to obey my sell by climbing slightly for the next month or two until it hit $69.86 on June 3. Shares then crept gradually lower until yesterday’s earnings report sent them down to $61.78, a drop of 3.75%.
It’s actually amazing to me that the stock didn’t fall further. For the quarter ended June 30, Qualcomm reported earnings of $1.2 billion, down from $2.2 billion in the year-earlier quarter. Revenue fell 14%. Chip shipments were flat year over year.
And then Qualcomm said things would be worse next quarter, the fourth quarter of Qualcomm’s fiscal year. For the quarter that ends in September Qualcomm projected earnings of 51 cents to 76 cents a share on revenue of $4.7 billion to $5.7 billion. The Wall Street consensus had seen the company earning 95 cents a share on sales of $6.13 billion.
Qualcomm’s quarter and its projections for next quarter highlight a problem across the technology sector. Very few technology companies are making very much money. And those that are can expect to see everybody including my Aunt Tilly chasing them. Qualcomm had averaged better than 20% annual sales growth since 2010 because of its dominance of the market for high-end chips that connect phones to the fastest data networks using the LTE standard. But that dominance has been under attack from companies such as Taiwan’s MediaTek, Korea’s Samsung, Arm Holdings (ARMH), and Intel (INTC). In fact in the first three months of the year Samsung and MediaTek grabbed 19% of the market. The loss of a huge order from Samsung’s smartphone business to Samsung’s chip unit was a major contributor to the end of a 19-quarter string of year over year sales growth at Qualcomm.
I don’t see the dynamic that turned this quarter into such a disappointment for Qualcomm turning around quickly. Qualcomm is predicting rather modest compounded annual growth of mid- to high-single digits in the 3G and 4G-device market over the next five years with average selling price (ASP) of the chips that go into those phones staying flat. That seems optimistic to me given that competition has been driving ASPs lower over the last couple of years, but the view is pessimistic enough to explain why so much of Qualcomm’s reaction to this quarter has focused on cost cutting–$600 million in fiscal 2016 and then an additional $1.1 billion in annual reductions.
The other part of Qualcomm’s response to the challenge of this quarter is to announce that it will be looking to address new markets with management citing networking, mobile computing, Internet of Things, and automotive as adding up to a $10 billion addressable opportunity now with growth to $20 billion by 2020.
I think you can readily see the problem with targeting those opportunities. Lots of competitors are going after the same markets—Cisco and Google (GOOG) in the Internet of Things, for example. Intel is willing to pour billions and then more billions into mobile computing. Apple and Google have both targeted the automotive opportunity.
That doesn’t mean it’s not worth going after these opportunities, but it is important to think about those opportunities in the context of the current pattern in the technology sector of one or two companies dominating a market and collecting all the profits from that market. Qualcomm cited in its conference call the growing concentration in its own sector. That’s a development that should be familiar to technology investors from the examples of Microsoft (MSFT), Intel, and Cisco Systems (CSCO). According to Qualcomm just two companies—Apple (AAPL) and Samsung account of 85% of the premium smart phone segment. The two companies account for an even bigger percentage of the profits in the smartphone sector: Apple accounts for 92% of profits in the smartphone sector, according to Canaccord Genuity, with Samsung pulling in 15%. The rest of the sector shows a loss—which is how Apple and Samsung can add up to more than 100%.
Looking at these numbers and trends I have to wonder if Qualcomm wouldn’t do a better job for shareholders if it eschewed the short-term solutions being urged on it by activist shareholders and instead concentrated on building an unassailable position in 5G technologies based on its clear lead in 4G technologies. That would produce some short-term pain, undoubtedly, since 5G technology is emerging only slowly. (From a long-term perspective it’s the lag in 5G adoption that accounts for much of Qualcomm’s current disappointment.)
And looking at the Qualcomm story I have to wonder if the pattern of concentrating all the profits in a sector in just a few companies doesn’t go a long way to explaining the number of young technology companies that are concentrating on growing revenue and market share as fast as they can—with the hope that someday that will result in the kind of market dominance that has made Apple such an amazingly profitable company.
Of course, it is a whole lot easier in the current technology market to build a strategy around growing revenue as fast as possible and letting profits take care of themselves somewhere down the road. At least that way a CEO doesn’t flag a profit opportunity and attract lots of competitors.
Yesterday disappointing quarterly results from Apple (AAPL), Microsoft (MSFT), and Yahoo (YHOO) took down those stocks. Apple, for example, reported a 38% increase in earnings year over year but fell 8% in after hours trading, wiping $66 billion off the stock’s market capitalization, as Wall Street analysts and investors decided that a mere 38% increase in revenue was a sign that growth was slowing at the company.
Today, the damage has spread to technology stocks in general—the iShares PHLX Semiconductor ETF (SOXX), for example, was down 2.52% as of 2:30 p.m. New York time, and the technology-heavy NASDAQ index was lower by 0.62%–and to shares of technology suppliers, and in particular Apple suppliers.
ARM Holdings (ARMH), down 4.6%, NXP Semiconductor (NXPI) down 2.6%, and Synaptics (SYNA) down 5.52% are among the hardest hit.
It hasn’t helped that Linear Technology (LLTC), a big name in analog chips, missed estimates for the quarter, supplied weak guidance for the next quarter, and noted that it had seen bookings slow “considerably” near the end of the quarter.
I think that the wider sell off is an over-reaction. Apple’s revenue “disappointment” was to announce just $49.6 billion in revenue when analysts had forecast $49.4 billion.
Yep, that’s right, Apple “disappointed” by only reporting revenues slightly above the official consensus projection for the quarter.
I don’t think the technology sector is out of the danger zone yet. Qualcomm (QCOM), a company with that has an Apple-like growth problem since it dominates its market, reports today after the close. I’d worry about another “disappointment.”
Two of the technology stocks that I’d most like to pick up on a sell off in the sector—NXP Semiconductors (NXPI) and Synaptics (SYNA)–report earnings on July 29 and July 30, respectively. And they’re both subject to a big drop on an Apple-like “disappointment. (That’s especially true for NXP, which trades at a trailing 12-month price to earnings ratio of 61. Synaptics trades with a PE of just 18.)
I’d wait on the earnings reports see if the market gives me good entry point for these stocks on near term fears in the sector.
Shares of Intel (INTC) have soared today after the company raised its guidance yesterday for second quarter sales. The stock is up 6.7% to $29.83 a share as of 3:30 P.M. New York time today. Intel is a member of my Dividend Income portfolio http://jubakam.com/portfolios/jubak-dividend-income/
Sure the capital gain is great—Intel’s share price is up 58.5% since I added it to this portfolio in September 2010.
But the surge in price has knocked the dividend yield to 3.1% from 3.3% in April. And this supposed to be a dividend income play.
Sell on the gain or hold?
Intel has done a good job in recent years of increasing its dividend payout as the share price climbed. We’re roughly on schedule for another dividend announcement in the next week or two. I’d certainly hold on through that and see what the company has to say. Whatever the company says about dividends, though, I think this stock’s price has further to climb. I’m raising my target price to $34 a share by December from the current target of $32 by November 2014.
Yesterday Intel said that it now expects second quarter sales of $13.7 billion. That’s a jump from the $13 billion in sales the company forecast back in April. Annual sales, Intel projects, will grow for the first time since 2011. Gross margin will climb to 64%, or 1 percentage point higher than it had last projected for the quarter, on higher PC unit volume.
The big reason is an improvement in sales of traditional PCs. Sales dropped 10% in 2013 and while market researchers IDC and Gartner are still projecting a drop in PC shipments for 2014, they’re now forecasting a smaller decline. IDC, for example, is now projecting a 6% drop in worldwide shipments. (The bad news is that IDC sees growth in PC shipments staying negative until 2018)
From what market researchers can see, it looks like corporate users have finally decided to replace their older PCs at a higher rate. A significant contributor to that trend is Microsoft’s decision to no longer support its long-in-the-tooth Windows XP operating system. That replacement cycle doesn’t fix the long-term problem of user moving from desktop machines to tablets and mobile devices and Intel still has to improve its penetration of those markets. But this kind of short-term news still helps.
Intel isn’t the only stock moving on the improved PC sales forecast. Microsoft (MSFT) was up 1.6% as of 3:30 P.M. New York time and shares of Hewlett-Packard (HPQ) were up 4.9%.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I managed, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund shut its doors at the end of May and my personal portfolio is now in cash. I anticipate putting those funds to work in the market over the next few months and when I do I’ll disclose my positions here.
On April 15 Intel reported first quarter 2014 earnings of 38 cents a share that beat Wall Street estimates by a penny.
But the big surprise—and the big story for technology investors even if they don’t own Intel shares—was the company’s gross profit margin for the quarter. Wall Street had expected 59% and Intel delivered 59.7%.
How’s that for a company that is cutting prices to break into new markets outside its core strengths in PCs and servers?
The price cutting is pretty aggressive. Digitimes reports that Intel has dropped its quad-core tablet processors to less than $5 in China. That brings Intel’s prices just about even with those charged by China-based chipset providers such as Rockchip Electronics and Allwinner Technology, and below the prices for chipsets from Nvidia (NVDA), Qualcomm (QCOM), and MediaTek.
China’s tablet market is projected as the fastest growing in the world in 2014 (global tablet shipments climbed 29.8% in 2013) and the level of technology in so-called white box tablets manufactured in China continues to climb. The price difference between older single core chips and the newer quad –core chips has dropped to about $1 and more and more white-box tablet makers are adding phone functionality to their tablets. Digitimes projects that 50% of white-box tablets will come with phone functions in 2014.
Intel sold 5 million tablet chips in the first quarter—quite a lot of chips for a company that wasn’t even a player in this market not so long ago. The company’s goal for 2014 is 40 million tablet chips. To get to that number Intel needs to grab market share from Chinese chip makers and from Qualcomm and MediaTek. Hence moves like the aggressive price cuts and the new $100 million Intel Capital China Smart Device Innovation Fund
To do that—break into and then grow market share in a new market—and not kill your company’s margins is extremely hard to do. And Intel is doing it in tablets, mobile, and what it calls the Internet of Things. These new efforts are still dwarfed by the PC Client Group ($7.9 billion in first quarter revenue) and the Data Center Group ($3.1 billion). The Mobile and Communication Group showed revenue of just $156 million in the quarter and the Internet of Things Group had revenue of just $482 million.
To generate the first quarter’s margin surprise then, Intel has continued to invest in chip manufacturing—annual capital spending at Intel is up 144% since 2009—even as most of its peers have thrown in the towel on in-house manufacturing and have joined the ranks of fab-less chip “makers” who outsource actual manufacturing to companies such as Taiwan Semiconductor Manufacturing (TSM.) These companies dropped out of manufacturing because they wouldn’t/couldn’t invest the level of capital spending necessary to sustain Moore’s Law. (Moore’s Law, named after Intel co-founder Gordon Moore and initially appearing in a 1965 paper, said that the number of transistors on a chip would double every two years. That would continue to drive processing power up and processing costs down.) Credit Suisse has called Intel the Last Man Standing on Moore’s Law.
If that’s true, and the first quarter margin numbers say it could well be, then Intel is the only chip company with this kind huge advantage. And that advantage would be enough to let Intel catch up in tablets, mobile, and the Internet of things. (I’d say Taiwan Semiconductor is still on the Moore’s Law path but the company is a manufacturer of other companies’ intellectual property.)
It’s still likely to take Intel a while to generate the kind of market penetration that it needs. The company is projecting flat revenue and earnings in 2014. But I think if the company can continue down this path for another two or three quarters, Wall Street will certainly start to notice.
Intel is a member of my Dividend Income portfolio http://jubakam.com/portfolios/ . (The shares pay a 3.3% dividend and the company is generating plenty of cash so that dividend increases—and share buybacks–are likely.) I’d set a $32 a share target price of Intel by November 2014.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/, I liquidated all my individual stock holdings and put the money into the fund. The fund did not own shares of Intel as of the end of December. In preparation for closing the fund at the end of May, as of the end of March I had moved the fund’s holdings almost totally to cash.
Terrible day for PC stocks—and it’s pretty much all Microsoft’s (MSFT) fault.
You see Microsoft’s new Windows 8 operating system—the big redesign with a touch screen—was supposed to revive PC demand.
And it hasn’t. In fact it looks like Windows 8 has made a bad situation worse as the redesign has driven away—or at least delayed their purchasing decisions–the corporate customers that are the remaining mainstay of PC demand.
At least that’s the conclusion from market watchers IDC and Gartner. IDC’s newest data, released yesterday, show worldwide PC shipments falling 13.9% during the first quarter from the level of the first quarter of 2012. Gartner’s numbers are only slightly less grim with the company estimating an 11.2% drop.
It’s not just that the numbers are so bad—it’s that they are so much worse than they were supposed to be. Read more