Better Buy: Micron Technology Inc. vs. Qualcomm Inc

By Markets

Memory chipmaker Micron Technology (NASDAQ: MU) and mobile chipmaker Qualcomm (NASDAQ: QCOM) have respectively rallied 19% and 31% this year, easily outperforming the Nasdaq's 4% gain.

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Those gains were surprising, since both chipmakers faced major headwinds last year -- Micron was hit by plummeting memory prices, and Qualcomm was losing market share in mobile chips. Let's discuss why both chipmakers bounced back, and whether or not either chipmaker is a worthy buy at current prices.

Image source: Pixabay.

Understanding Micron and Qualcomm's challenges

Micron ranks fourth in the global NAND market after Samsung, Toshiba, and Western Digital's SanDisk -- inthat order. It ranks third inthe mobile DRAM market after Samsung and SK Hynix. This ongoing competition from larger rivals has traditionally been tough on Micron's margins. Meanwhile, anoversupply of flash memory has reduced average selling prices, and the integration costs of its manufacturing processes at its combined Elpida and Micron fabs has further weighed on itsbottom line.

Qualcomm is the world's largest maker of mobile system on chips (SoCs), which bundle application processors, baseband modems, GPUs, and other features onto a single chip. Qualcomm generates most of its revenue from this business, but cheaper rivals like MediaTek and first-party chipmakers like Samsung and Huawei have reduced its market share.

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Qualcomm generates most of its earnings from its higher-margin patent licensing business, which takes a 3% to5% cut of the wholesale price of every smartphone sold worldwide. However, that business has been under pressure due to original equipment manufacturers (OEMs) and regulators demanding lower fees to compensate for the plunging margins on mobile device sales.

Image source: Qualcomm.

Evaluating the potential catalysts

Micron is trying to widen its competitive moat by developing faster memory technologies, like 3D NAND and 3DXPoint, with its longtime partner Intel. Intel, which abandoned its own DRAM efforts in1985 amid tough competition, is frequently cited asa potential suitor for Micron, which has an enterprise value of $23 billion.

The main near-term catalyst for Micron would be the tightening of DRAM and NAND supplies across the market, which would boost average selling prices. Recent comments fromHP CEO Dion Weisler about component shortages andaDigiTimes article -- which claimed that DRAM spot prices had hit a seven-month high in September -- support that bullish thesis. As a result, analysts expect Micron's revenue to rise 21% thisyear and another 6% next year.

Qualcomm is diversifying its chipmaking business into adjacent markets like connected cars, drones, wearables, smart home appliances and other Internet of Things (IoT) gadgets. To achieve that, it acquired IoT chipmaker CSR for $2.4 billion last year, launched custom SoCs for specific devices like wearables and drones, and might even buyNXP Semiconductors-- thebiggest automotive chipmaker in the world -- for over $30 billion.

As for the licensing business, Qualcomm has been securing new licensing contracts with deadbeat OEMs (mainly in China), which underreported shipments to pay lower fees. The acquisition of CSR, potential purchase of NXP, and its own research and development should also expand its patent portfolio to cover adjacent markets, thus reducing the segment's overall dependence on smartphones. These moves are encouraging, butanalysts still believe that Qualcomm's revenue willfall 8% this year before rebounding 2% next year.

Profit growth and valuations

Micron has posted negative earnings for three consecutive quarters, but rising memory prices are expected to lift it back to profitability, with earnings of $0.19 per share this quarter. Micron's annual earnings are expected to rise from $0.06 in 2015 to $1.17 in 2016, and rise another 50% in 2017. Those growth estimates make Micron's forward price-to-earnings ratio of 15 look fairly cheap.

Qualcomm remains highly profitable, but the pricing pressures at its chipmaking business and its licensing woes could cause its earnings to fall 8% this year. However, Qualcomm's new flagship chipsets, its expansion into adjacent markets, broadening patent portfolio, and resolved licensing conflicts are expected to boost earnings by 10% in 2017. That rebound is encouraging, but the growth rate remains lower than its forward P/E of 14 -- indicating that the stock isn't that cheap. But if Qualcomm buys NXP, its chipmaking margins could improve as it scales up.

Micron doesn't pay a dividend, but Qualcomm pays a forward yield of 3.2%, which is easily supported by its trailing-12-month payout ratio of 57%. That dividend, which has been hiked for 13 consecutive years, should limit the stock's downside during market downturns.

The winner: Micron

I own shares of Qualcomm and believe that it's a solid long-term investment, but Micron looks better at current prices. Its top and bottom lines could grow much faster, thanks to tightening NAND and DRAM supplies and rising prices, and its valuation indicates its potential growth hasn't been fully priced in yet. Qualcomm is a reliable income play, but it could take a much longer time for its expansion into adjacent markets to pay off.

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Leo Sun owns shares of Qualcomm. The Motley Fool owns shares of and recommends NXP Semiconductors and Qualcomm. The Motley Fool owns shares of Western Digital. The Motley Fool recommends Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.