Broadcom Stock: One Of The Best In The Industry (NASDAQ:AVGO)

Broadcom Expected To Beat Quarterly Earnings Expectations

Justin Sullivan

Investment Thesis

Broadcom (NASDAQ:AVGO) is one of the most resilient semiconductor companies on the planet, and this is a very strong quality to possess during the uncertain economic times we are experiencing. The company reported strong results on the 1st of September and growth remained very strong. I am stunned to read about those results and then see how the stock price did so far this year. Broadcom is down over 34% so far this year while posting 25% revenue growth, while other semiconductor companies are seeing massive slowdowns. Just look at the horrible year of Intel (INTC) so far, or the profit warnings at NVIDIA (NVDA). Just last week, AMD (AMD) gave a profit warning and TSMC (TSM) and Samsung (OTCPK:SSNLF) saw a slowdown in chip manufacturing. And through all of this, Broadcom remains strong, posting great results, and still gets butchered YTD. If I could only pick one company within the semiconductor industry, this would have to be either Broadcom or ASML (ASML). Broadcom is a very strong buy for me at current prices as I will show you in this article.

Broadcom Inc.

Headquartered in San Jose, California, Broadcom is a global infrastructure builder with its roots in AT&T/Bell Labs and Hewlett Packard/Agilent. Broadcom focuses on technology that connects the world and does this through a combination of industry leaders, namely LSI, Broadcom Corporation, Brocade, CA Technologies, and Symantec. Broadcom (the enterprise name) is a company focused on category-leading semiconductor and infrastructure software solutions. Below, there is an oversight of the history and creation of the Broadcom we know today, created out of several acquisitions. The latest of which is under regulatory check. This is the pending acquisition of VMWare (VMW) for $61 billion in a cash and stock deal. Another of the many acquisitions of Broadcom to diversify its business with software, next to its strong semiconductor business.

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Overview Broadcom (Broadcom)

Broadcom has a market cap of $194 billion. Broadcom is not just a semiconductor manufacturer as I mentioned before, but also for a part, a software company. Revenue is divided into approximately 73% semiconductor and 27% software business. Within the semiconductor business, Broadcom works mostly on communicational semiconductors. It makes semiconductors for Networking, broadband, server storage, wireless, and industrial. Its software business exists of mainframe, DevOps/ValueOps/AiOps, cybersecurity, and storage area networking. This is what Broadcom says about its products:

Broadcom’s diverse product portfolio includes leading semiconductor and infrastructure software solutions. Its semiconductor portfolio includes data center switches and routers, set-top/CMTS, cable modems, and PON/DSL, Ethernet NICs, filters and amplifiers, ASIC, wireless connectivity solutions, embedded processors, HDD/SSD controllers, enterprise SAS/SATA/Fibre Channel connectivity, optical isolation/motion encoders/LEDs, and fiber optic solutions. Its infrastructure software portfolio includes enterprise solutions for building, connecting, managing, and securing complex digital environments.

The big upside to Broadcom’s product portfolio is its exposure to certain industries which are not exposed to consumer spending. In the case of a recession and less consumer spending, as we are seeing all around us, Broadcom’s business remains resilient. Other semiconductor companies such as NVIDIA and AMD are already seeing a significant slowdown in revenue. Semiconductors are cyclical, and although I believe they will become less cyclical in the future, the semiconductor business of Broadcom is not that cyclical. The Broadcom chips are being used in pretty much all products using an internet connection and this gives the company a huge business. Broadcom is also an important supplier for Apple (AAPL). The software business is even less cyclical. Cybersecurity and other infrastructure software that Broadcom delivers to businesses is not something companies can cut back on. Keeping your infrastructure business up to date is crucial to deliver the best results and products to consumers.

All in all, Broadcom remains strong even under current circumstances and its services and products remain sticky.

Results

On the 1st of September, Broadcom announced its 3Q22 results. The company reported strong results with revenue coming in at $8.5 billion, up 25% YoY. GAAP net income was $3.1 billion; adj. EBITDA of $5.4 billion. GAAP EPS grew to $7.15 and free cash flow was $4.3 billion. Free cash flow was a strong 51% of total revenue. These results represented excellent YoY growth and free cash flow was massive because the company has no problems with its margins. CEO Hock Tan said the following about this:

Broadcom’s record third quarter results were driven by robust demand across cloud, service providers, and enterprise. We expect solid demand across our end markets to continue in the fourth quarter, reflecting continued investment by our customers of next generation technologies in data centers, broadband, and wireless.

Broadcom gave guidance for approximately $8.9 billion of revenue in 4Q22, an expected increase of 20% YoY. This means growth is here to stay for Q4. The company expects no slowdown at all, which is remarkable compared to other semiconductor peers. Kirsten Spears, CFO, also noted that she expects free cash flow to remain strong.

Results were strong and the company is seeing no slowdown in the business for 4Q22. Yet, as stated before, the stock price is down 34% YTD.

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Broadcom YTD (Yahoo Finance)

This performance is significantly worse than the performance of the S&P 500, which is down 23.64% YTD. I know that tech stocks are getting hammered so far this year and the semiconductor companies, most of all, are having a very tough year. This seems justified for some companies who are seeing massive slowdowns, but for many, this is an unjustified drop. Broadcom is seeing no slowdown and the stock is dropping like a brick anyways. This seems like a miss valuation by Mr. market and a great opportunity for investors.

Balance sheet and valuation

Broadcom is valued at a forward P/E of 11.7. This is extremely cheap for a company growing 24% YoY in the most recent quarter. This is an undervaluation compared to the sector by 30%, while the growth rate is higher than the sector median. Seeking Alpha Quant rewards this undervaluation with a B+ rating. Revenue growth and EPS growth are 5% and 218% higher than the sector average and this shows just how undervalued this enterprise is.

The company has a strong balance sheet but does have a lot of debt. Broadcom is a special case regarding its debt because it takes on debt to fund its acquisitions, which does bring a lot of risk with it (I will discuss this in further debt in the threats section). Broadcom has been exceptional in dealing with its debt and integrating new businesses. Broadcom and CEO Hock Tan are acquisition specialists. The current free cash flow shows how exceptional the company is in transforming revenue into free cash flow. This free cash flow can then be used to reward its shareholders and pay off its debt. The acquisition of VMWare does bring on some additional debt and so this is something to monitor in the future. It is also important to note that the businesses Broadcom is acquiring are enterprise software businesses and these generally have higher margins, so margins would probably improve for Broadcom, which then makes it easier to pay off debt with more cash generated. Total debt was $39.5 billion at the end of the last quarter.

Broadcom is also one of the dividends-paying semiconductor companies. They pay a 3.75% yield, which is very high. This forward yield is 100% higher than the sector median and therefore deserves a Quant rating of A. It is not just the yield that is amazing, the company also has amazing dividend growth. The 5-year average dividend growth is a staggering 32% and this is 230% higher than the sector median. This is exceptional growth supported by its strong portfolio growth and acquisitions. The 3-year growth rate is a bit lower at 15%, but still 80% higher than the sector median. Growth gets an A+ from Seeking Alpha Quant. The payout ratio is also under 50%, so the company has no problems consistently paying its dividends and receives an A+ on this front.

Broadcom has been paying its dividend for 10 years now and has been growing it for these same 10 years. The track record is strong, safety is good, yield is very strong, and growth is exceptional. Broadcom is a dividend monster, supported by strong growth and huge amounts of free cash flow.

Outlook

Broadcom confirmed its outlook and expected 20% growth for the coming quarter, despite the current economic problems and the slowdown within the semiconductor sector. For the next 3 years, analysts remain positive but expect Broadcom to post slower growth.

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Projected EPS (Seeking Alpha)

Above we can see growth slowing down significantly. I think analysts are too conservative here as I think the current tailwinds of more digitalization, like IoT and 5G, are giving the company a boost to keep posting strong results. Yes, I do expect a slowdown, but I believe Broadcom will be able to keep posting above 10% growth YoY. I think the acquisition of VMWare, once completed, will give Broadcom a strong boost in the software business as well. This is a big acquisition and will make it a big software player. The current valuation of Broadcom is probably being suppressed because of this pending acquisition. Once completed, Broadcom will be challenged to merge this company into its business and to improve its cash flows as fast as possible to pay off the debt. Current CEO Hock Tan is one of the best at it and has done it many times before, with stellar results. I do not think we should underestimate this man and his vision. Hock Tan is one of the best CEOs in the world. He became CEO of Avago in 2005 and lead the acquisition of Broadcom in 2015. He then led all the acquisitions which I showed a little earlier in this article. He is the creator of the Broadcom we know today and led this company to a $200 billion market cap. If there is one man whose vision and actions I trust, it will be this man.

To support my opinion and thesis, I just want to point out that Broadcom receives a strong buy from Seeking Alpha Quant and Wall Street analysts with 17 analysts out of 26 having a strong buy on the company with just 4 hold and no sell ratings. The average price target is 655, which from current levels represents almost 50% upside potential.

Threats

Even a beautiful business like Broadcom is not without any risks. One of the main risks will be its debt level, which will be even higher after the acquisition of VMWare. If a situation would occur under which the company would not produce the same cash flows as today, the debt level could become too high to bear and then the dividend could be at risk. VMware’s growth is slowing quickly over the last year, and so Broadcom has a challenge on its hands to get this business back to strong growth. If Broadcom would not succeed at this, VMware could become a drag on earnings and margins for Broadcom.

An economic slowdown and possibly a recession could eventually have an impact on earnings for Broadcom and slow down growth.

I think all of these risks are already priced and so I see only upside potential for Broadcom.

Conclusion

Broadcom is one of my high-conviction stocks in my personal 28 stocks portfolio and one of my bigger positions. At current prices, the company is very cheap and a clear strong buy. The company continues to show very strong growth and sees no slowdown as of yet. If the company manages to deliver on next quarter’s results, a bounce back to above 600 per share is highly likely. The exceptional dividend, low valuation, and high growth make the stock a beautiful buy at current prices. The stock has been pulled down with the rest of the semiconductor sector, completely unjustified, and so this is a rare occasion for any investor to buy a beautiful company at a discount. Broadcom is a very strong buy for me.

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