Shares of semiconductor giant Broadcom (AVGO 3.84%) have more than doubled in the past year, but they fell nearly 7% in early March after the company released results for fiscal 2024's first quarter (ended Feb. 4) -- and that was despite better-than-expected numbers.
Broadcom's revenue and earnings exceeded expectations, while its fiscal 2024 revenue guidance of $50 billion was slightly ahead of the $49.8 billion consensus estimate. Investors, however, were probably expecting more from Broadcom in light of the company's growing artificial intelligence (AI) business.
Let's take a closer look at Broadcom's quarterly results and check if its latest drop is a buying opportunity for investors.
Results were solid, and AI business could accelerate
Broadcom delivered fiscal Q1 revenue of almost $12 billion, an increase of 34% from the year-ago period. This revenue included the contribution from VMware, which Broadcom acquired in November last year. On an organic basis, Broadcom's revenue increased 11% year over year. The company's adjusted earnings, meanwhile, increased 6% to $10.99 per share.
It is worth noting that Broadcom's quarterly revenue growth accelerated when compared to the 4% year-over-year organic jump it recorded in the fourth quarter of fiscal 2023. A key reason behind Broadcom's improved revenue growth was the stronger-than-expected demand for its AI chips. CEO Hock Tan remarked on the latest earnings conference call that Broadcom saw robust demand for "custom AI accelerators at our two hyperscale customers."
Tan added that Broadcom is now expecting AI chips to produce 35% of its semiconductor revenue in fiscal 2024, up from the earlier projection of 25%. More specifically, Broadcom anticipates ending the fiscal year with $10 billion in AI chip sales. That's a nice acceleration in the quarterly run rate when compared to the $1.5 billion of AI chip revenue that Broadcom generated in the fourth quarter of fiscal 2023.
Based on its full-year revenue forecast of $50 billion, AI chip sales are set to account for 20% of Broadcom's fiscal 2024 revenue. However, it won't be surprising to see Broadcom raising its AI-related revenue guidance as the year progresses. That's because the demand for custom AI accelerators is estimated to clock a healthy annual growth rate of 20% in the future, according to J.P. Morgan.
Broadcom's 35% share of the market for advanced application-specific integrated circuits (ASICs) means that it is well-placed to take advantage of this market that's reportedly worth between $13 billion to $18 billion a year at present. However, there are certain pockets of weakness in Broadcom's semiconductor business that investors should note.
The company's revenue from the semiconductor solutions business was up only 4% year over year to $7.4 billion despite the better-than-expected sales of AI chips. That wasn't surprising as Broadcom's revenue from the wireless business was down 4%. The business accounts for 27% of the company's semiconductor revenue and the weakness here can be attributed to underwhelming iPhone sales.
Apple's iPhone shipments are expected to drop in 2024, according to noted analyst Ming-Chi Kuo of TF International Securities. As Apple procures wireless chip components from Broadcom for deployment in its iPhones, there is a chance that the latter could continue to witness weakness in this segment. Not surprisingly, Broadcom predicts that its wireless semiconductor business will turn in a flat performance this year.
On the other hand, the company is anticipating its revenue from selling server storage connectivity chips and broadband chips to decline by big margins in fiscal 2024 thanks to the weakness in these end markets. So, buying Broadcom stock based on its AI potential alone may not be the right move as it relies on other markets for 80% of its revenue, and it is facing challenging conditions in some of those areas.
The valuation is another point of concern
Broadcom stock's big surge in the past year means that it is trading at an expensive valuation. The stock has a price-to-sales ratio of almost 15, which is more than double its five-year average of 7. The trailing price-to-earnings ratio stands at 49 as compared to the five-year average of 33. This probably explains why the stock dropped following the latest earnings report.
Investors would have liked to see Broadcom raising its full-year outlook. But as the company's AI-driven strength was offset by a tepid performance in other areas, it was unable to do so. What's more, Broadcom may have to compete with AI chip leader Nvidia in the future as the latter is reportedly looking to get into the market for custom AI chips.
So, buying Broadcom in the wake of its post-earnings drop doesn't look like a smart move to make right now. However, investors would do well to keep this semiconductor stock on their watch lists as a potential turnaround in its ailing segments along with the strength of its AI business could help it regain its mojo.
