Broadcom Tests Negative for Coronavirus, and Bludgeoned Shares Look Like a Deal

Late last week, chipmaking and enterprise software giant Broadcom (AVGO +0.53%) reported fiscal 2020 first-quarter results (for the three months ended Feb. 2, 2020) that were slightly below expectations but free of coronavirus disruption. What has turned into a broad panic on Wall Street in the past few weeks actually started out as worry that the illness's origin in China would create a supply shock to the global economy. Nevertheless, in spite of China's lockdown to contain the spread of COVID-19 (including manufacturing facility closures and subsequent cancellation of some shipments of goods), Broadcom said all was looking OK at the moment.

Despite that level assessment on its current situation, the big tech outfit did withdraw its full-year 2020 guidance due to the evolving situation, opting instead to provide an outlook for the second quarter. After an initial steep pullback, the stock rallied with the rest of the market on Friday afternoon to end an ugly week for Wall Street. However, Broadcom shares are down nearly 30% from all-time highs registered just a month ago. It's anyone's guess where the market decides to go next, but Broadcom's sell-off is looking way overblown given the information available at the moment.

Image source: Getty Images.

The quarter by the numbers

After growing revenue and free cash flow (what's left from revenue after basic operating and capital expenses are paid) by 8% and 12% respectively last year, Broadcom got the new year off to a strong start. Its core semiconductor business, which makes up about three-quarters of total revenue, fell 4%, but that was more than offset by a 19% gain in its infrastructure software for networking, data centers, and cloud computing -- which got a big boost from the addition of the Symantec enterprise cybersecurity segment.  

All told, the quarterly report ended up close to being in line with how management said it would go: Low single-digit growth in Q1 and improving through the second half of 2020.

Pp = percentage point. Data source: Broadcom.  

While CEO Hock Tan said Broadcom saw no ill effects from supply or demand disruption because of coronavirus, investors did worry that full-year 2020 guidance -- previously 11% revenue growth and 9% adjusted EBITDA (earnings before interest, tax, depreciation, and amortization) growth -- was pulled for now. Tan explained on the earnings call:

So now let's talk about the impact of COVID-19 on that outlook. As I sit here today, I have not yet seen a meaningful impact on bookings and certainly the fundamentals of the business remain very much intact. However, there is no doubt COVID-19 has created a high level of uncertainty which we can't help but think is going to have an impact on our semiconductor business, in particular in the second half of the fiscal year. But frankly visibility is bad and confidence continuing to erode. So as a result, we believe it is only prudent that we draw our annual guidance until such time that visibility returns to pre-COVID-19 levels.  

Worried about buying too soon?

There was some consolation, though. While the full-year picture is cloudy, Broadcom did issue expected numbers for Q2: $5.7 billion in revenue plus or minus $150 million (a 3% increase from a year ago at the midpoint) and $3.135 billion adjusted EBITDA plus or minus $75 million (a 55% profit margin and a 0.7% increase at the midpoint). Clearly, though more growth would be nice, investing in Broadcom is all about the tech giant maintaining high profit margins and lowering debt associated with the Symantec and other software acquisitions from the past few years.

Of course, there is a worry that new coronavirus disruption in Europe and the U.S. could send what started as such a promising year into reverse. When queried by analysts on the conference call, though, management remained confident that its profit margins will stay intact even if sales do fall.  

That's good news because the real reason to purchase Broadcom is for the dividend (currently yielding 5.9%) paired with long-term, slow-and-steady expansion. That dividend remains well-covered by free cash flow, leaving plenty of room for the company to work down its debt ($42.4 billion at the end of Q1). Management's ability to get more efficient post-takeover of Symantec will be what to watch in the next few quarters.

Nevertheless, I like the chipmaking giant's chances, and shares look especially appealing since the recent panic-induced bloodbath the last few weeks. I remain a patient shareholder and a happy dividend receiver at this time.