The fallout from the U.S.-China trade war and blacklisting of Chinese tech giant Huawei has hit semiconductor companies especially hard. The building blocks of technology are hurting because a significant amount of their manufacturing process takes place in China, and Huawei has become a large customer for many. The Chinese telecom equipment and smartphone maker recently said it could lose $30 billion in sales the next two years, leaving its haul this year and next around $100 billion.
Connectivity chip maker Skyworks Solutions suffered a beat-down earlier this month when the company said it had suspended all sales to Huawei to comply with the Trump administration's order. Broadcom (NASDAQ:AVGO) is the latest to get hit by the crackdown. The company recently released second-quarter fiscal 2019 results that were good, but the outlook for the rest of the year lost some of its sparkle. Not to fear, though: This chipmaker is still worth a look despite its recent tumble.
Q2 and beyond
Broadcom has been in a bit of a slump this past year. When excluding results from its acquisition of CA Technologies in the autumn of 2018, sales have been in a slight decline. However, Broadcom has built its business on takeovers, and it redomiciled from Singapore back to the U.S. in early 2018 to make it easier to acquire U.S. companies.
The reasoning for the relocation was sound, and the U.S. chip business was on its way to real growth once again. But as a U.S.-based company once again, Broadcom is now in line to lose sales to Huawei because of the national security-based blacklisting. The damage is expected to be $2 billion in lost sales for the balance of the year, reducing the company's outlook to $22.5 billion for full year 2019.
There is somewhat of a silver lining, though. In large part because of strength in the higher profit margin infrastructure software business, adjusted operating margin is now expected to be 52.5% instead of 51%. That could mean bottom-line gains are still in the cards and could extend the stock's 2019 to-date rally.
Is the sell-off overdone?
Sales growth will be roughly stagnant for the rest of 2019 now, but that isn't the case for profits. Besides getting the CA Technologies bump, Broadcom has also recently refinanced its debt to extend maturities and lower interest rates. The company also continues to pay a 4% annual dividend and is on track to repurchase over $8 billion in stock this year.
Despite the trade-war headwinds, free cash flow -- money left over after basic operating expenses and capital expenditures -- was up 20% in the second quarter and is expected to end 2019 at $9 billion, compared with $8.25 billion in 2018.
Thus, the Huawei ban will be a significant headwind, but not an insurmountable one. Substantial worry over how the chip industry will be affected the second half of 2019 is already priced in. With a trailing-12-month price to free cash flow of just 13.1, Broadcom still looks like a buy to me. If the trade war gets sorted out, growth could be back in the cards sooner rather than later.