Can This Stock Head Higher Post Earnings?

Harsh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Spreadtrum Communications (NASDAQ: SPRD), the China-based fabless semiconductor company has had a terrific run over the past six months, appreciating 40%. When I had first trained my eyes on this stock in May this year, it had successfully quashed negative sentiments around it with a strong quarterly report. Since then, Spreadtrum has been on a tearing run.

However, it had faltered badly on outlook when it reported its second quarter almost three months back, sending its stock down the drain. But Spreadtrum has picked up the pieces since then, recovering the value it had lost on that glum day.

The company is expected to report its third quarter earnings this week on November 8, tentatively. Will Spreadtrum provide more impetus to its stock price through its next report and guidance, or will it have to endure another steep drop like last time? How are the company’s long-term prospects? What are the threats? Does it still make a good investment option? Let’s check out.

What to Expect?

Expectations from Spreadtrum have already inched down as the company had guided below consensus estimates last time.  Constrained supply of 2.5G handset components and low sales of high-end smartphones were the reasons behind a subdued outlook. This, along with fears of an economic slowdown of the Chinese economy (where Spreadtrum plies its trade), had sent the stock down 15% three months back.

Hence, I believe that most of the bad news is already priced into the stock. And considering that estimates are already at the lower end of the spectrum, the company should be able to beat them. In addition, Spreadtrum had said last time that it doesn’t expect any more declines in gross margin, driven by increased sales of high margin yielding smartphone products. So, I expect that the company will be able to coast clear of bottom line estimates as well.

This leaves one piece that needs to fall into place nicely if the stock is to receive a bump and carry on its positive momentum – guidance.

The Guidance Game

Spreadtrum’s sales have gained in the two quarters reported so far this fiscal year, and are expected to go up once again when it comes out with third quarter numbers. The company’s outlook had suffered due to a shift in consumer preference to low-end phones, but at the same time it was witnessing a ramp up of high-end smartphone sales.

Spreadtrum had said that it expected to move more than 10 million smartphone chips in the quarter that just ended. This means that the company is seeing a gradual ramp up in shipments and the guidance could probably be an upbeat one. Also, Spreadtrum is expected to launch its 1.2 GHz single-core and dual-core smartphone platforms along with new WCDMA products. Being the leading player in the Chinese smartphone chip market, these products might further help Spreadtrum in parking its guidance ahead of Street estimates.  

For the Long-term

China Mobile (NYSE: CHL), which is the world’s leading wireless provider and Spreadtrum’s largest customer, should drive its results in the long run. China Mobile has a huge handset replacement market, which is expected to clock 100 million units a year. Moreover, China Mobile is driving the growth of TD-SCDMA based handsets, and Spreadtrum happens to be the biggest supplier of these chips to the wireless behemoth.

In addition, Spreadtrum has a war-chest of design wins for its 1 GHz TD-SCDMA chips to boast, 200 to be precise. With the introduction of the 1.2 GHz version, the company should manage to do even better in the future. Spreadtrum supplies chips for premium and well-known smartphones such as Samsung Galaxy S III’s TD-SCDMA version from China Mobile.

The Chinese smartphone represents a huge opportunity for Spreadtrum and it would most probably ride the growth in high-end smartphones in the region on the back of its products. Additionally, presence of China Mobile as a client is another huge plus. Also, Spreadtrum is looking to establish a foothold in the booming Indian market for budget phones through its partnership with Micromax and this could be another potent driver for the long run.

Some Threats for the Long Run

However, the Chinese TD-SCDMA market is stiffly competitive. Spreadtrum faces pressure from the likes of RDA Microelectronics, and more importantly from chip bellwether Qualcomm (NASDAQ: QCOM). Qualcomm is pressing into the TD-SCDMA space and poses the most potent challenge for Spreadtrum.

Qualcomm has reportedly found its way into the China Mobile account through its Snapdragon S4 processor in Nokia’s latest flagship, the Lumia 920. The foray of a chip giant such as Qualcomm is indeed a big threat for Spreadtrum and potential investors should keep an eye on how the market plays out.

The Bottom line

Spreadtrum’s third quarter report should provide further clarity on how high-end smartphones are playing out in China. But from a long-term perspective, the company does look like a decent investment option. Competition is indeed quite stiff in the TD-SCDMA market, but so far Spreadtrum has managed to do well.

I am eagerly waiting to hear what Spreadtrum’s management has to say on the conference call. Tune into this space again in a few days for more insight on where Spreadtrum is headed.

TechJunk13 has no positions in the stocks mentioned above. The Motley Fool owns shares of China Mobile and Qualcomm. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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