Is Broadcom Stock a Buy?

Broadcom's (AVGO 3.84%) stock has tripled over the past five years as the wireless chipmaker once known as Avago aggressively expanded through big acquisitions. Avago gobbled up the original Broadcom in 2016, assumed its name, and acquired the network equipment maker Brocade in 2017.

The new Broadcom expanded into the infrastructure software market by acquiring CA Technologies in 2018 and Symantec's enterprise security business in 2019. It even nearly took out Qualcomm (NASDAQ: QCOM) with a hostile bid before the Trump administration blocked the takeover.

Investors might be reluctant to buy Broadcom after its multiyear rally, but the stock still looks surprisingly cheap at 16 times forward earnings, and it pays an attractive forward yield of 3.3%. Let's dig deeper to see why Broadcom could still have room to run.

Image source: Getty Images.

A well-diversified company with a popular top customer

Broadcom's core semiconductor business, which produces a wide range of wireless chips for various industries, generated 77% of the company's revenue last year. The remaining 23% mainly came from its infrastructure software unit.

Broadcom's top customer is Apple (NASDAQ: AAPL), which accounted for 20% of its revenue last year. That's still a sticky partnership: Back in January, Apple agreed to buy what Broadcom thinks will work out to roughly $15 billion in wireless components from Broadcom over the next three and a half years.

That amount should equal nearly a fifth of Broadcom's revenues over the next three years. Broadcom's dependence on Apple might wane slightly as it sells more chips to other customers, but it should remain one of the top iPhone supply chain players for the foreseeable future. While iPhone sales have slumped, demand for the iPhone 12, Apple's first 5G phone, should generate tailwinds for Broadcom's chipmaking business next year.

Broadcom also provides chips for telecom, data center, and cloud companies. Its chips enable wired and wireless networks to run at higher speeds, and it bundles its infrastructure software with its silicon to widen its moat against other network chipmakers like Cisco.

Broadcom is a "fabless" chipmaker, meaning it outsources the production of its chips to another foundry, which is less capital-intensive than producing chips internally. TSMC, the world's largest contract chipmaker, manufactures most of Broadcom's chips. 

How fast is Broadcom growing?

Broadcom's revenue rose 8% in fiscal 2019 thanks to the robust growth of its data center chip and infrastructure software businesses. Its adjusted EPS, which excludes its acquisition-related expenses, grew 2%.

Broadcom's revenue rose 4% year-over-year in the first nine months of 2020. Its semiconductor revenue declined due to pandemic-related disruptions, but its takeover of Symantec's enterprise security business (which closed last November) boosted its infrastructure revenue. 

Image source: Getty Images.

Broadcom's sales of its network and broadband chips stabilized in the second and third quarters, and its total semiconductor revenue rose sequentially in the third quarter. 

That recovery was buoyed by Broadcom's telecom and cloud customers, which upgraded their networks to address the rising bandwidth needs for remote work and other online activities. Cloud customers purchased more of its Tomahawk 3 and Trident 3 switch products, while telecom customers ramped up its high-speed Jericho 2 routing solution for core and edge networks.

Broadcom expects its growth to accelerate as pandemic headwinds wane, infrastructure upgrades continue, and new 5G devices hit the market. It expects its fourth-quarter revenue to rise 11% year-over-year at the midpoint, and for its adjusted EBITDA to grow 18%.

Analysts expect Broadcom's revenue and earnings to rise 6% and 3%, respectively, this year. Next year, they expect its revenue to rise 9%, with 16% earnings growth, as the pandemic passes and the aforementioned secular tailwinds accelerate again.

Rising free cash flow with sustainable dividends

Broadcom paid out $1.3 billion in dividends in each of the first three quarters of 2020. Those payments were easily covered by its free cash flow, which has risen consistently over the past year.

YOY = year-over-year. Data source: Broadcom.

Over the past 12 months, Broadcom spent just 48% of its FCF on its dividend. This gives the chipmaker plenty of room to continue its nine-year streak of annual dividend hikes. 

Broadcom still owed $44 billion in debt at the end of the third quarter due to its aggressive acquisitions, but just $800 million of that debt matures within a year. That short-term debt can be easily covered by its $13.9 billion in liquidity, which includes $8.9 billion in cash and a $5 billion revolving credit facility.

Still a solid long-term semiconductor play

Broadcom might not seem as exciting as other higher-growth chip stocks, but it's a well-diversified chipmaker that will benefit from rising demand for wireless chips across multiple industries. Its stock is cheap relative to its growth, it pays a high dividend, and it weathered the COVID-19 crisis with minimal damage. In short, I believe Broadcom remains a solid long-term investment on the booming semiconductor market.