Qualcomm (NASDAQ: QCOM), the biggest mobile chipmaker in the world, started paying a dividend in 2003. It raised its payout annually every year since then, and currently pays a forward yield of 4.4%, making it one of the highest yielding "mature tech" stocks on the market.
When we combine that high yield with Qualcomm's P/E of 20, which is lower than the industry average of 23 for semiconductor makers, the stock looks like a solid income play for conservative investors. However, several major headwinds caused Qualcomm shares to drop 20% this year and erase those dividend-related gains. Let's see if those headwinds will persist, and whether or not they could hurt its dividend growth.
Continue Reading Below
What headwinds does Qualcomm face?
Qualcomm generates most of its revenue by selling mobile chipsets for smartphones and tablets. That business is ceding market share to cheaper rivals like MediaTek and first-party chipsets from smartphone giants like Apple (NASDAQ: AAPL), Samsung, and Huawei.
Most of Qualcomm's profits come from its higher margin licensing business, which uses a portfolio of wireless patents to earn a cut of all smartphones sold worldwide. That business is being aggressively targeted by regulators and OEMs, which claim that Qualcomm's cut (up to 5% of the wholesale price of a device) is too high.
Qualcomm was already fined in China and South Korea over those licensing practices, and faces similar probes in Taiwan, Europe, and the United States. Apple is also suing Qualcomm over unpaid rebate payments (in exchange for the use of its baseband modems in iPhones) and alleges that the chipmaker's licensing business model is "illegal".
Apple halted all licensing payments to Qualcomm, and Qualcomm retaliated by suing the iPhone maker's suppliers -- resulting in a game of chicken which could hurt both companies. That's why Wall Street expects Qualcomm's revenue and earnings to respectively slide 2% and 6% this year.
How could this affect Qualcomm's dividend?
Over the past 12 months, Qualcomm spent 82% of its earnings and 84% of its free cash flow (FCF) on dividend payments. Both figures, as seen in the following chart, represent all-time highs for the company.
If those percentages exceed 100%, the dividend could be cut. Those payout ratios rose because Qualcomm's earnings and free cash flow growth slowed down. Qualcomm's non-GAAP net income and earnings fell 28% annually last quarter, due to the aforementioned headwinds facing its licensing business, and that decline won't end until it makes peace with Apple, other OEMs, and government regulators.
Qualcomm's free cash flow also gradually declined over the past three years, as it spent more heavily to ensure that its flagship Snapdragon SoCs remained the "best in breed" chipsets for mobile device makers.
These charts paint a gloomy picture for Qualcomm's long-term future as an income investment. But if Qualcomm can revive its earnings and free cash flow growth, its payout ratios should drop to more sustainable levels again. It can accomplish all that by closing its acquisition of NXP Semiconductors (NASDAQ: NXPI).
Why the NXP deal will be a game-changer
Qualcomm announced that it would acquire NXP, the biggest automotive chipmaker in the world, last October. That move, which would expand its addressable markets by about 40% by 2020, would instantly reduce its dependence on the mobile market and counter the headwinds facing its chipmaking and licensing businesses. Qualcomm expects the deal to be "significantly accretive" to its earnings growth once it closes.
Qualcomm's payout ratios should cool off after that acquisition closes, allowing it to continue its 14-year streak of dividend hikes. However, it's unclear when the deal will actually close -- the deal has been approved by U.S. regulators, but remains stuck in limbo in Europe.
So is Qualcomm's dividend sustainable?
Qualcomm's dividend is sustainable for now. But investors should realize that its earnings and free cash flow are still declining, while its payout ratios are soaring. If Qualcomm survives the ongoing attacks from OEMs and regulators, and closes the NXP deal quickly, those figures should start moving in the right directions again.
But if regulators force Qualcomm to slash its licensing fees or the approval for the NXP drags on, it could eventually reduce its dividend. Therefore, income investors can still buy Qualcomm, but it certainly isn't a stock that you can simply "buy and forget".
10 stocks we like better than QualcommWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Qualcomm wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of August 1, 2017
Leo Sun owns shares of Qualcomm. The Motley Fool owns shares of and recommends Apple. The Motley Fool owns shares of Qualcomm. The Motley Fool recommends NXP Semiconductors. The Motley Fool has a disclosure policy.