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Is Broadcom Stock a Buy?

By Leo Sun – May 19, 2020 at 8:49AM

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This tech giant is trading at a low valuation and paying a 5% dividend yield.

Broadcom's (AVGO -1.87%) stock has more than doubled over the past five years as the chipmaker, formerly known as Avago, expanded via a series of major acquisitions. Avago bought Broadcom for $37 billion in 2016, assumed its name, and relocated its legal address from Singapore to Delaware the following year.

It subsequently bought Brocade for $5.5 billion in 2017, CA Technologies for $18.9 billion in 2018, and Symantec's enterprise security business for $10.7 billion in 2019. It also nearly bought Qualcomm (QCOM -2.01%) before the Trump administration blocked the $117 billion hostile bid on national security concerns.

Those deals turned Broadcom into one of the world's largest chipmakers, but its stock still looks surprisingly cheap at 12 times forward earnings with a forward yield of 5%. Should investors accumulate more shares at these levels, or will the massive chipmaker struggle with the COVID-19 headwinds?

A picture of a circuit board.

Image source: Getty Images.

How fast is Broadcom growing?

Broadcom's revenue rose 8% to $22.6 billion in 2019, fueled by robust demand for its data center chips and the growth of its infrastructure software business. It generated 77% of its revenue from semiconductor solutions, another 23% from infrastructure software, and the remaining sliver from IP licenses. Its acquisitions of CA and Symantec's security unit reduced its earnings by 78%, but its adjusted EBITDA -- which excludes those impacts and other one-time charges -- rose 14% to $12.6 billion.

Broadcom's revenue rose 1% annually to $5.9 billion in the first quarter. Its semiconductor revenue dipped 4% to $4.2 billion, but its infrastructure software revenue -- boosted by its recent acquisitions -- rose 19% to $1.7 billion and offset that decline.

Broadcom generated 14% of its revenue during the quarter from an unnamed top customer, most likely Apple (AAPL -1.51%). Broadcom provides wireless components for Apple's devices, and it recently agreed to provide Apple with $15 billion in wireless components over the next three years.

Broadcom's gross margin expanded annually from 44.6% to 55.7% during the quarter, thanks to the growth of its higher-margin software business. Its operating margin also expanded from 9.6% to 12.2% as it reduced its total operating expenses by 4%. As a result, its adjusted EBITDA rose 1% to $3.3 billion.

How will COVID-19 affect Broadcom?

CEO Hock Tan stated: "The fundamental semiconductor backdrop has been improving, and we did not see any material impact on our businesses due to COVID-19 in our first quarter." However, Tan also warned the "visibility in our global markets is lacking and demand uncertainty is intensifying."

A transparent view of a smartphone.

Image source: Getty Images.

Nonetheless, Broadcom expects its revenue and adjusted EBITDA to rise 3% and 1% year-over-year, respectively, in the second quarter. But it also withdrew its previous forecast for fiscal 2020, which called for 11% revenue growth and 9% adjusted EBITDA growth.

During the conference call, Tan warned a "possible" downside scenario could cause Broadcom's 2020 revenue to come in 5%-10% lower than its original forecast. Meanwhile, analysts expect Broadcom's revenue and earnings to rise 4% and 1%, respectively, this year. Investors should take both forecasts with a grain of salt since the COVID-19 crisis is rapidly evolving.

Broadcom's free cash flow rose 9% annually to $2.2 billion during the first quarter, which easily covered its $1.3 billion in dividend payments. Its cash and equivalents rose 27% to $6.4 billion. Therefore, Broadcom should easily continue its 10-year streak of dividend hikes, and it still has plenty of cash to gradually reduce its $44.7 billion in debt. Only $2.3 billion of that total matures within a year.

Broadcom's tailwinds should offset its headwinds

Broadcom's chip and software portfolios are diversified across the data center, networking, broadband, wireless, storage, industrial, and enterprise and mainframe markets.

Demand for data center upgrades should remain robust throughout the pandemic as stay-at-home measures boost the usage of cloud-based and streaming services. Sales of smartphone chips could also accelerate in the second half of the year as new 5G smartphones hit the market. Meanwhile, the industrial and enterprise markets could remain sluggish due to the aftershocks of COVID-19.

Simply put, Broadcom remains a macro play on the semiconductor and software markets. It doesn't face many individual competitors, but its growth could remain tepid until stronger tailwinds spark fresh demand for its chips and infrastructure software.

The bottom line

Broadcom's stock might not rally anytime soon, but its low valuation and high yield should limit its downside potential. Therefore, I believe it's still a safe income stock that could generate solid returns over the next few years.

 

Leo Sun owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool owns shares of Qualcomm. The Motley Fool recommends Broadcom Ltd. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Broadcom Limited Stock Quote
Broadcom Limited
AVGO
$468.68 (-1.87%) $-8.93
Apple Inc. Stock Quote
Apple Inc.
AAPL
$150.43 (-1.51%) $-2.31
QUALCOMM Incorporated Stock Quote
QUALCOMM Incorporated
QCOM
$121.19 (-2.01%) $-2.49

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