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Qualcomm Stock Upgraded: What You Need to Know

Rich Smith, The Motley Fool

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

Qualcomm (NASDAQ: QCOM) has had an up-and-down year. One of the biggest names in semiconductor chips globally, Qualcomm shares are up 27% over the past 52 weeks -- but at one point, Qualcomm stock was actually down 28% from its highs of January. Now the question is, will Qualcomm relapse, or is this rally sustainable?

One analyst thinks it is. This morning, Rosenblatt Securities announced it's upgrading shares of Qualcomm to buy and assigning a $70 price target. As StreetInsider.com (subscription required) explains, the analyst believes that Qualcomm will benefit as 5G wireless technologies roll out across the globe.

Here's what you need to know.

Semiconductor chip on blue background

Image source: Getty Images.

What went wrong with Qualcomm

Is that likely? Before deciding if Rosenblatt is correct about Qualcomm being worth $70, it's worth taking a look first at what has already gone wrong with the company. Let's start with the business model.

As my fellow Fool.com contributor Leo Sun has written, Qualcomm gets most of its revenue from selling Snapdragon systems on chips to cellphone manufacturers to incorporate into their phones. But Qualcomm gets most of its profit from licensing its cell technology to manufacturers -- taking as much as a 3% to 5% cut of the purchase price of phones that use its technology.

Qualcomm's rivals and regulators object to this business practice, however, and think it has gotten too greedy. In recent quarters, regulators have begun levying billion-dollar fines against the company to punish it for how it's been calculating licensing fees. Tallying up these fines and deducting them from its earnings cost Qualcomm nearly $2 billion over the past 12 months, according to S&P Global Market Intelligence figures. On top of that, in Q1 2018, Qualcomm got hit with a $6 billion tax charge related to tax reform, pushing the company $6 billion into the red for the period. GAAP losses are now $4.2 billion for the past 12 months, and Qualcomm now looks on course to book its first full-year net loss since the dot-com burst back in 2001.

Always darkest before the dawn

None of that sounds particularly propitious for Qualcomm. And yet, Rosenblatt believes things will soon start looking up for the company.

In today's note, the analyst argues that "Qualcomm will benefit from growth in the 5G smartphone market over the next few years," inasmuch as its "5G RF module is better positioned" than its previous 4G module, while its rival MediaTek is "losing traction" in smartphone chipsets.

The analyst also sees revenue possibilities in the increasing adoption of fingerprint sensors to unlock smartphones (the analyst predicts a "ramp" in production in 2019), and even a chance that Apple will choose to put Qualcomm's 5G modem in its new phones instead of using a modem from Intel.

As for Qualcomm's failed attempt to purchase NXP Semiconductors, Rosenblatt argues that that disappointment is already "priced into the stock." That theory, by the way, seemed confirmed when Qualcomm finally called off the merger due to Chinese regulators' repeated delays in approving it -- and Qualcomm stock went up, not down, on the news.

An unobvious bargain

Speaking of Qualcomm's stock price, I have to say that when I look at it today, I get the distinct impression this stock isn't quite as unprofitable as it appears.

As I mentioned up above, Qualcomm currently has no P/E ratio and $4.2 billion in trailing GAAP losses. Analysts polled by S&P Global further expect the company will lose money this year -- about $3.7 billion.

And yet, these same analysts predict Qualcomm will bounce back to earn a $4.7 billion net profit in 2019 (roughly twice what it earned in 2017, before Q1's several charges to earnings). This likely profit, even in the face of regulators apparently trying to force the company to modify its business model, is encouraging. In this regard, it's worth noting that as the regulatory situation gets more clear, analyst earnings estimates are going up, not down. According to Yahoo! Finance, analyst estimates for this year's earnings have climbed 11% in the past 90 days, and their expectations for 2019 earnings have increased 18%!

Meanwhile, despite its several charges to earnings, Qualcomm's cash flow statement shows the company has already generated positive free cash flow of $5.6 billion over the past 12 months.

With Qualcomm sporting a $97 billion market capitalization and holding $13.5 billion in net cash on its balance sheet, I ballpark the company's enterprise value at just $83.5 billion -- or less than 15 times free cash flow. Analysts see the stock growing earnings at 12.5% over the next five years, and when you factor in its 3.8% dividend yield, that works out to a total return of about 16.3%.

To me, a 16.3% return is more than enough to justify paying less than 15 times FCF for Qualcomm stock -- and Rosenblatt is right to recommend it.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends AAPL. The Motley Fool owns shares of Qualcomm and has the following options: long January 2020 $150 calls on AAPL and short January 2020 $155 calls on AAPL. The Motley Fool has a disclosure policy.