Qualcomm (NASDAQ:QCOM) has Taiwan Semiconductor Manufacturing Company (NYSE:TSM) as its largest supplier in China. Data from Bloomberg’s Supply Chain Database indicates that TSM has 5.29% revenue exposure with Qualcomm, yet Qualcomm has 15.75% cost exposure with TSM. TSM’s financial reporting provides a unique information advantage to Qualcomm shareholders: In Taiwan, all public companies must report monthly revenue by the 10th of the following month to MOPS (Market Observation Post System). As TSM is a Taiwanese public company, it provides monthly revenue reporting, which is not required in the U.S. The shorter horizon monthly revenue data gives Qualcomm investors more timely information regarding current demand on Qualcomm products than Qualcomm’s own quarterly earnings announcement in the U.S. It is the thesis of this post to show that the company’s stock prices are materially affected by their major suppliers’ financials, especially if they are reported earlier.

TSM’s Monthly Revenue Leads Qualcomm’s Quarterly Revenue

TSM sources 5.3% revenue from Qualcomm. The sheer size suggests that TSM’s revenue growth will directly reflect the China and world demand on Qualcomm’s CPU products. Qualcomm also incurs 15.75% of their cost of goods sold from TSM, which makes TSM the largest Qualcomm supplier in China. As Qualcomm always have the most current information on its global product demand as well as the current inventory, when Qualcomm foresees changes, they will adjust new orders to the suppliers accordingly. As a result, TSM’s monthly revenue has to be the first place to reflect such changes. Through this link, TSM’s revenue is bound to correlate with Qualcomm revenue growth over time, as shown by the close co-movement between TSM’s revenue and Qualcomm’s quarterly revenue (Figure 1C). This is why TSM’s future revenue growth is an important indicator of Qualcomm’s future revenue growth. On average, for every $1 billion change in TSM revenue, Qualcomm’s revenue will by $2.5 billion. Historically, TSM’s February revenue, averaged around $150 million, is often the lowest monthly revenue because Chinese New Year 2-week holiday usually falls in February (Figure 1). Though, 2019 February’s $200 million has been the lowest February since 2014.

In the past, there has been a causal relationship from TSM Revenue to Qualcomm’s revenue, as TSM represents 15.75% of the cost of goods sold. In Figure 1C, it appears that TSM’s monthly revenue led Qualcomm’s quarterly revenue, as indicated by the rise and fall of TSM’s monthly revenue (points A-D) often preceded the rise and fall of Qualcomm’s quarterly revenue. The relationship may be due to the fact that TSM’s revenue change indicates Qualcomm’s cost change, which reflects the world demand change for Qualcomm’s product. The lead-lag relationship seems to work at both the top and the bottom of the revenue cycle. Roughly, there is a 2-month lead for TSM to rise or fall before Qualcomm does.

It should be particularly noted that such a repetitive lead-lag relationship is very difficult to obtain and thus extremely valuable. This is the beauty of a stable supply chain which can be used to predict the customers’ future revenue growth. For example, TSM’s monthly revenue tends to rise 2 months before Qualcomm’s quarter revenue’s rise. The same lead applies to the revenue decrease. In other words, Qualcomm’s revenue will only rise or fall two months after TSM’s changes. If this pattern is stable enough, it will provide a reasonable base for forecasting Intel’s (NASDAQ:INTC) 1H 2019 revenue. Although TSM’s Feb. 2019 revenue was not terribly lower than previous years’ level, it is also not ready to rebound yet since it usually takes TSM at least 6 months to bounce off its low revenue. Even if TSM’s revenue were to hit the low now, it will take at least another two months for Qualcomm’s revenue to hit the bottom. In other words, Qualcomm still looks to see a lower 1H 2019 revenue.

Cautions

For investors looking for early signals of future growth, cautions should be taken in interpreting the seemingly obvious “leading indicators” shown in previous graphs. Clearly, TSM has many other customers, so its monthly revenue changes can be easily triggered by revenue event risk of any one of those other customers. On the other hand, if three of the largest TSM’s tech customers all exhibit a similar 2-month lagging pattern, I am fairly confident in the validity of the predictive power of the pattern.

QCOM Prices Track TSM’s Revenue

That being said, since this (leading) relationship has been historically repetitive and can be easily reasoned through, any reasonable investors should also expect that the pattern may have been baked into the stock prices. Thus, is there any remaining value for this information for investors? For this question, I compared Qualcomm’s stock prices with TSM’s monthly revenue and Qualcomm’s quarterly revenue estimates. The comparison is intended to see whether Qualcomm’s stock prices and quarterly revenue estimates have reflected TSM’s monthly revenue. From Figure 2, the answers are yes and no. Yes! Qualcomm’s stock prices correlated more with TSM’s monthly revenue than with Qualcomm’s own quarterly revenue estimates. No! The Qualcomm’s consensus quarterly revenue estimates do not seem to relate directly to the changes in TSM’s monthly revenue. On one hand, the result is encouraging in that investors have incorporated the relevant information in a company’s supply chain. On the other hand, the result is discouraging in that investors are “smarter” than the professional analysts in terms of using relevant information.

Takeaways

While there is some evidence that stock prices move with its supplier’s monthly revenue more than with the company’s own quarterly revenue, one practical question is that whether the current stock prices fully price in the information content in TSM’s monthly revenue. For that, I correlated the actual Qualcomm’s stock price with its own quarterly revenue estimate as well as TSM’s monthly revenue. Using this approach, I was able to estimate the future revenue-driven “fair value.” Qualcomm’s fair value is $51, compared to the actual price at $53.26. QCOM is overvalued about 5%. For all practical purpose, QCOM is fairly valued, assuming future revenue the sole driver of valuation.

Finally, my thesis in this post is that company stock prices are affected by their major suppliers’ financials, especially if they are reported earlier. For the cases of Qualcomm which has a large supply chain, its largest supplier TSM’s advanced monthly revenue reporting provides leading information regarding their future quarterly revenue. Using this information, Qualcomm’s stock may be better valued.

Incidentally, the motivation behind this post is derived from a smart comment in a previous post. SA Poster, Irrerational, said,

“We need to fish out all the early indicators we can get about a company to verify what we think. It may not be a sufficient condition, since Foxconn supplies to other companies as well, but if all circumstantial evidences support our thesis, the chance of being right is much higher.”

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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2019-03-28