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Qualcomm’s 10% Dividend Increase: Built on the Back of Future Growth

Chip manufacturer and CDMA specialist Qualcomm Inc.’s (QCOM ) recent 10% jump in its dividend from 48 cents to 53 cents per share highlights its mature stature in the world of tech. After all, no matter what the wireless device, there’s a good chance that QCOM has provided the necessary guts to make it work. That supreme supplier status has made the tech stock a cash flow machine over the years.

However, recent developments, such as slowing sales in its key divisions, have caused some reservation among investors and traders in QCOM shares. Those hiccups even have investors questioning Qualcomm’s ability to realize such large dividend increases in the future.

But rest assured, that sort of dividend increase is really built on the back of long-term future growth. QCOM’s latest forays into some of tech’s hottest trends play directly into its core businesses. For investors, its recent 10% dividend jump might only be the beginning as Qualcomm rolls out its plans.

First, Some Recent Problems

Qualcomm is engaged in the development and commercialization of a digital communication technology called code division multiple access (CDMA) and the orthogonal frequency division multiple access family of technologies, such as long-term evolution (LTE). The company’s products principally consist of integrated circuits (chips or chipsets) and system software used in mobile devices and in wireless networks. Basically, all the stuff that’s needed to make smartphones, tablets and other wireless devices run in the real world.

That’s been really a great place to be over the years. However, lately, QCOM hasn’t exactly been firing on all cylinders.

For starters, Qualcomm is playing catch up. The smartphone era in which Qualcomm flourished during the bloody pricing wars between various smartphone makers is now maturing. At this point, everyone has a smartphone. Efforts by outsiders to the industry such as Facebook (FB ) and Google (GOOG) question the very need to build wireless infrastructure. Without wireless infrastructure, Qualcomm’s trove of CDMA patents will remain a lost treasure. This is not going to happen soon, but Qualcomm does need to prepare for a future without CDMA and perhaps LTE.

Second, Qualcomm’s core business continues to be afflicted negatively. As of late, there have been murmurs of Apple (AAPL ) using Intel (INTC ) to power its chipsets in the next generation of iPhones. Should Apple end up choosing Intel over Qualcomm, the headline risk of a Qualcomm in decline will be far greater than a short-term hit to revenues.

And it’s not just Apple that is becoming dissatisfied. The firm’s recent sales decline in 2015 was also a result of manufacturers’ growing dissatisfaction with licensing fees to Qualcomm. Manufacturers in China have been strongly vocal in their displeasure with QCOM and have vowed to reduce dependency on the firm.

As for that core business itself, it is slowing. Qualcomm is largely a cyclical play. And as we’ve reached the end of the cycle, calls for a break up have grown. However, Qualcomm has thus far resisted calls for a break up. At $77 billion, Qualcomm is a gigantic company. Breaking it up into industry-focused segments, such as traditional “boring” wireless businesses that include CDMA/patents and newer “exciting” divisions, could provide a richer valuation for QCOM shares.

Still Plenty of Growth Ahead

For QCOM, there’s no need to break up. There’s still plenty of growth potential ahead as a combined company. That comes from connected cars, smart homes, wearable devices and the Internet of Things (IoT). Long-term and well-respected CEO Steve Mollenkompf has explained to shareholders that the company’s moves in industries such as connected cars, IoT and smart homes are expected to widen the market available for Qualcomm to over $100 billion over the next decade. There is certainly an onus to invest in these areas and, ultimately, they pair well with the need for more wireless infrastructure and QCOMs bread-and-butter businesses. Qualcomm is better as a whole.

But just to be on the safe side, looking at the “next big thing” in wireless technology doesn’t hurt either. Management has been very vocal in wanting to use some of their $40 billion cash pile to make large, strategic acquisitions. However, it should be noted that most acquisitions in the semiconductors and chip-making business have seen mediocre success at best owing to technology integration issues.

QCOM Is Priced for Growth With a Side of Dividends

With the real potential to expand into high tech areas, such as the IoT, that complement QCOM’s rich traditional businesses, Qualcomm has plenty of growth ahead. It also has plenty of income potential as well. Those CDMA patents and sales produce plenty of earnings and cash flows.

Qualcomm’s balance sheet looks very healthy as well. Although annual revenues declined in 2015, they still came in at $25.2 billion with profits of $5.27 billion. This implies a net margin that is just shy of 20%, a very healthy number for any company. Gross margins for the latest quarter were in the 60s, roughly in line with peers such as Intel. Meanwhile, free cash flows were $4.5 billion. Those cash flows have helped QCOM reward shareholders. Further, the stock has a dividend yield of 4.19%. Its latest increase was on April 8.

Although Qualcomm has a considerable amount of debt, most of it is long term, and QCOM’s CDS reflect optimism among key debt holders. Debt management is clearly not a problem at this company.

With respect to the firm’s valuation, Qualcomm is valued at 2.45x book value and 3x sales, implying a relatively healthy period of earnings over the next three to five years. Qualcomm has a P/E ratio of 16.89, in line with mature players in the market such as Intel, but well below newcomers in the smartphone chip making space such as Texas Instruments (TXN ) and Nvidia (NVDA ). All of the above implies a rather rosy picture, which is made even rosier considering QCOM’s potential in new areas.

The Bottom Line

Qualcomm is one of the stalwarts in the smartphone area. It has consistently shown that its engineers are capable of shaping the future. However, worries have recently crept into the firm’s narrative. But investors shouldn’t worry. QCOM has plenty of growth ahead. Considering these risks, fundamentals and potential opportunities, believes QCOM is a safe buy and its 4% yield is icing on the cake