and the European Union, which could cost the company hundreds of millions in financial penalties.
The good news is that current investors’ pain could be future investors’ gain. Qualcomm stock has been so beaten down that it looks cheap in comparison to the broader stock market. And, Qualcomm sports a hefty 4% yield, with a balance sheet loaded with cash. If Qualcomm can sort out the various challenges hanging over its head, it could be an attractive turnaround stock for 2016.
Qualcomm Muddles Through 2015
Qualcomm has dealt with several regulatory investigations this year. First, Qualcomm was forced to pay $975 million earlier this year to settle anti-monopoly concerns by the China National Development and Reform Commission.
More recently, Qualcomm revealed it was hit with antitrust charges by the European Union. It is also facing possible regulatory action in South Korea as well.
If that weren’t ugly enough, Qualcomm believes many of its licensees in China have been under-reporting device sales to pay Qualcomm lower royalties. This has been an issue all year, and although Qualcomm notified investors it reached a settlement with an undisclosed large licensee in China, the damage has been done.
Last fiscal year, Qualcomm’s revenue and diluted earnings per share fell 5% and 31%, respectively.
Free Cash Flow, Strong Balance Sheet Provide a Floor
Fortunately, Qualcomm has some weapons in its armory. First, the stock now provides a 4% dividend yield. This is a high yield that towers above the technology sector average. Qualcomm’s dividend looks covered, as the company still generates very healthy free cash flow.
Qualcomm generated $4.5 billion of free cash flow last fiscal year. That represents a 17% free cash flow margin as a percentage of revenue. In that time, its dividend cost the company 63% of its total free cash flow. That leaves more than enough room to continue growing its dividend, and also allowing the company to reinvest back into future growth opportunities.
Second, Qualcomm is in strong financial position, with a balance sheet stuffed with cash. As of the end of last quarter, the company held $30.9 billion of cash and marketable securities on the balance sheet. All this cash provides a lot of financial flexibility.
Qualcomm’s current ratio is a robust 3.6, which implies significant short-term liquidity. Moreover, Qualcomm’s long-term debt to equity ratio is a healthy 31%, which means investors don’t have to worry about burdensome debt dragging the company down going forward.
Catalysts for Future Growth
The most promising catalyst for Qualcomm’s future growth is its massive corporate restructuring plan, which management announced earlier this year.
Going forward, Qualcomm will reduce its stock compensation by $300 million annually. Moreover, it will seek $1.1 billion in broader cost cuts each year, which it believes will not impact its growth priorities. This plan could bring Qualcomm’s expenses down by several percentage points, and significantly help boost margins back to satisfactory levels.
Plus, the hefty $975 million fine that weighed down Qualcomm in 2015 won’t be an issue next year.
One catalyst that does not seem likely for the foreseeable future is a spinoff of its chip and patent businesses, which certain investors had urged management to consider. This week Qualcomm’s board of directors unanimously decided against a spinoff.
While both businesses are large enough to stand on their own, the businesses work well together. The QCT business provides applications processors and baseband devices, while the QTL segment monetizes Qualcomm’s massive patent portfolio. The company holds sizable negotiating leverage on both sides of the overall business. As a result, the two segments produce complimentary operational efficiencies, which would be upended if the company split itself up.
Even so, there are enough forward catalysts working on Qualcomm’s behalf.
Qualcomm has been a dog stock throughout 2015. But heading into 2016, its cheap valuation (10 times earnings), 4% dividend yield, and significant restructuring efforts could pave the way for a much better year ahead.
DISCLOSURE: Bob Ciura personally owns shares of Qualcomm (NASDAQ: QCOM).
This article is brought to you courtesy of Bob Ciura from Wyatt Research.