SWKS - Standing Tall With Qorvo

2023-12-19 01:54:40 ET

Summary

• Qorvo reported in-line results for September and guided flat for December, but the market reacted negatively.
• The market's reaction was seen as a mistake, as Qorvo's performance and new design win were positive.
• QRVO is expected to experience significant market growth in the future.

Qorvo ( QRVO ) reported slightly higher than in-line results for the September quarter guiding flat for December. The next day, the market took the price apart before closing almost unchanged. In our view, from the treetops, the market got it, badly wrong, badly wrong. In past articles, we discussed the company's superior technology with respect to others in the same sector. Our last article, Qorvo, Now Potentially Another Apple Surrogate with Its Massive Win , contained a meaningful discussion about its possible massive new design win with Apple ( AAPL ). The focus on Qorvo's market penetrating technology continues adding size details plus a discussion of changing market forces. From treetops, investors may advantageously observe both the macro and fine details important in making investor decisions. In our view, earnings growth will return from three sources. Find your harness, spikes, pulleys, and rope, and start the ascent. It can be exhausting, yet it comes with incredible views along the way.

Company Summary

Qorvo is an American multinational company specializing in products for wireless, wired, and power markets." - Wikipedia

It divides itself into three segments: Advanced Cellular ((ACG)), High Performance Analog (HPA), and Connectivity & Sensors ((CSG)). In the last reported quarter, ACG was 77%; HPA was 14%; and CSG was the balance at 9%.

The Shorten Version of the Quarter

Beginning with the quarter and adding details concerning the new design win, particularly of its size, we start the ascent. A short version of the September report follows:

• Revenue above guidance at $1.1B.
• Margins equaling 47.6%.
• Non-GAAP earnings of $2.39.
• Flat revenue guidance for December.
• Lower margins for December range between 43% and 44%.

Management wrote:

The primary driver was a large smartphone customer ramp. In addition, channel inventories of Qorvo components across the Android ecosystem continued to be consumed with OEMs indicating inventory levels are approaching historical norms."

It can't be overstated that the growth is from new wins not the return of business. Qorvo, also, sold the biometrics business but will continue supplying BAW filters to the buyer.

Coming Growth with a Return to Normal

Coming growth might be huge with a step change in revenue and markets returning to more normal unit volumes. It might be better than investors are thinking. We begin with revenue patterns that clearly show how deeply stuffed the channels, in particular Android, became.

* Prior to September of 2023, Apple's revenue represented approximately 33% of Qorvo's business.

** Guided.

Management discussed the nature of its China market. The designs reside in China's export markets. The competition some believe is coming isn't the issue with Qorvo; it's about a return in unit sales. They also reminded analysts that Samsung represents a large part of the coming 5G growth.

Describing out-of-phase sectors, CSG is now back growing, while HPA isn't expected to grow until March. Within HPA, the base station market dropped by 50% for the last four quarters incurred mainly by the U.S. Government's ban on Huawei. With respect to China OEMs, management noted, "[a]ll we'd add is we are still under-shipping to end demand best we can tell. But we're coming up near the end of it."

Management constantly reenforced market status stating that it hasn't yet fully recovered. The growth we are seeing is from new organic wins. The revenue data shows how deeply the inventory issue with Android and the Asian market became with its 40% drop. We discussed this precipitous drop in revenue in part, because of the importance it has in understanding the magnitude of the Apple win.

The Apple Win

So, next, we look at the size of the Apple design win(s) with hopefully a more accurate value. It begins with the guidance flat between December and September. Management explained in part the reasons. The design isn't part of the motherboard rather it is part of the flex circuits, thus ramp times are different, earlier than most. When asked about the size of the win by Karl Ackerman of BNP Paribas, Grant Brown, CFO, refused to answer on a quarterly basis. But he did add this interesting comment:

And I'll start with our largest customer because it's been questioned before. But our growth this year and our largest customer really speaks to the strong position we have there... This year, we grew mostly from new content and gained some share in sockets that we held for many years."

In order to evaluate the Apple win in better detail, a backward review seems in order. For the September quarter, ACG equaled 77%. Also noted: for the June quarter of 2023, revenue by segment was $412 million for ACG, $140 million for HPA and $99 million for CSG. Now, the table with the September results follows.

* Collapse in non-Apple revenue in December and March quarters significantly skewed the Apple percentage upward. Long-term 33% is still a valid percentage.

** Raised the percentage for the quarter with September and December being seasonally higher with Apple ramps.

*** Rounded result.

**** Cirrus Logic ( CRUS ) reported half of its general market business, most of which is Android on a year over year basis. Cirrus provides audio solutions to a very similar Android market, with roughly the same customers in the same phones but at much lower ASPs. In guessing the September Qorvo Android revenue, we halved the 2022 Android for September of 2023.

The approximate calculation equaled $675 minus $400 times 2 (seasonally high Apple quarters) divided by 0.55. It appears to us that the design wins for Qorvo equals between $0.8B-$1.2B significant, yet lower than our first estimate of 1.8B using limited data.

Other Business Competition

On competition, analysts asked continually about Huawei and other China competition. Management responded that Huawei's growth was significant for that company, but insignificant within the market Qorvo sells and continually reminded analysts that Qorvo's business in China is in exported products. It is a different animal. Management has sent a representative to China recently for a first-hand look at its business.

Improving Margins

A third means of growth is margins. The business, at lower rates, experienced significantly lower margins. Management explained in more detail the continuing issue with Grant Brown, company CFO, offering this insightful comment:

I... wouldn't think of it in terms of an absolute revenue level, but rather a time of us to move through our high-cost inventory, return utilization levels back to normal, run the factories efficiently, and we'll be on a path back to 50% plus.

A few additional comments about inventory follow. Days of inventory materially dropped in September from 210 to 138. Underutilization and factory-related variances equaled 550 basis points down from 800 in June. With a large portion of products manufactured at third-party locations for September, the margin improved slightly. For December and March, high-cost inventory sales from internal production will negatively affect margins. Management expects 50% plus margins at least in the larger quarters to return during the 2nd half of 2024 and going forward. On the issue of volumes, Qorvo is starting to see the bloating in channel inventory subside. It's now about getting the company's excesses back in line.

Growth Markets

The growth story doesn't end with an Apple win and markets returning to normal. The company feels optimistic about the high-end phone market. With fewer than half of the phones being 5G, double-digit growth is expected to continue for several years. It continues to win additional products in this space enjoying multiple opportunities. Qorvo produces highly integrated parts targeted at Android. The integrated approach within this market is highly valued.

With its Apple business, management noted, "So clearly, that's a target of growth for us, and we'll continue to invest to be able to win there. Now that's also regardless of the baseband they decide to use."

In other markets with transitioning to DOCSIS 4.0 and broadband beginning, the company continues its progression through functional integration for 5G massive-MIMO deployments. Ultra-wideband, a technology in which Qorvo excels, and its force-sensing products, are in the early innings.

Adding the Numbers

Three clear areas offer growth, the return to more normal Android phone sales, major win(s) with Apple, and an increase in margins to above 50%. With respect to the first, the business experienced a 40-50% decline for the past year. From the above table, the loss is in the $400 - $500 million per quarter. Our estimate for the Apple win equals approximately $1 billion or slightly lower per year. Margins fell approximately 8 percentage points lowering earnings by approximately 15%. Remember, margin compression will continue for at least two more quarters. In FY-2022, the last full year of stellar performance, the company earned in excess of $12 per share. With the possible $0.80 - $1.0 billion coming in new design win revenue at 51% margin, this amount represents an additional $4 +. The stock is now priced near $100, extremely cheap in a long-term view. With earnings from Apple at $4 and past earnings at full Android unit rates expected over the next few years at $12, the stock has room to move back above $150 toward the $200 range (PE will still be under 15 at $200 with a future earnings above $15). We included several comments and thoughts from Qorvo's management concerning market conditions. The comments seem consistent with others in the space such as Skyworks ( SWKS ) and Cirrus Logic leaving us without reason for doubting management. It likely represents the best available near-term conditions.

Risks

In our view, the major risk is within smartphone unit volumes continuing to compress. But even that is a matter of time. We, also, still might be high with revenue increases from the Apple win, but more wins are also likely coming. In our estimates, we excluded future growth in markets still in the early innings. With the stock priced even in the recent run-up, we view this as an expectational buying opportunity. Yes, it could head lower in the short term from a recession worry or actual occurrence. In our view, buying Qorvo in multiple and timed purchases is in order. We continue our strong buy rating. From the top, it's a beautiful view.

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