Broadcom's (AVGO -1.07%) stock has surged 45% since the beginning of the year. The diversified chip and infrastructure software company impressed the market with its stable growth, a new multiyear deal with Apple (AAPL 1.69%), and the potential benefits from its planned takeover of cloud software giant VMware (VMW).
But should investors still buy Broadcom after that massive rally, which outpaced the Philadelphia Semiconductor Index's 38% gain during the same period? Let's review Broadcom's business model, growth rates, and valuations to decide.
A rapidly expanding and evolving tech giant
The original Broadcom was acquired by its Singapore-based rival Avago Technologies in 2016. Avago subsequently rebranded itself as the new Broadcom, relocated its headquarters to the U.S., beefed up its chipmaking business with more acquisitions, and expanded into the infrastructure software market by acquiring CA Technologies in 2018 and Symantec's enterprise security unit in 2019. It nearly acquired Qualcomm via a hostile takeover before the U.S. blocked the deal in 2018, and its planned takeover of VMware still needs to clear a lot of regulatory hurdles.
In fiscal 2022 (which ended last October) Broadcom generated 78% of its revenue from its semiconductor business, which produces a wide range of chips for the mobile, data center, networking, wireless, storage, and industrial markets. The other 22% of its revenue came from its infrastructure software business. Here's how those two businesses fared over the past year.
Revenue Growth by Segment (YOY) |
Q2 2022 |
Q3 2022 |
Q4 2022 |
Q1 2023 |
Q2 2023 |
---|---|---|---|---|---|
Semiconductor solutions |
29% |
32% |
26% |
21% |
9% |
Infrastructure software |
5% |
5% |
4% |
(1%) |
3% |
Total |
23% |
25% |
21% |
16% |
8% |
The growth of Broadcom's semiconductor business decelerated for two reasons: Its sales of mobile chips cooled off as the 5G upgrade cycle ended, while the macro headwinds curbed its sales of chips to IT infrastructure customers. It expects its semiconductor revenue to only rise by mid-single digits year over year in the third quarter, which implies the business hasn't quite reached its cyclical trough yet.
However, two catalysts could revive Broadcom's semiconductor business over the long term. First, Apple -- which accounted for a whopping 20% of Broadcom's revenue in fiscal 2022 -- recently signed a new multibillion-dollar agreement to buy the chipmaker's 5G radio frequency components and other wireless connectivity components. Second, Broadcom expects the growth of the generative AI market -- driven by popular chatbots like ChatGPT -- to boost is sales of data center and infrastructure chips. It believes the AI market will account for more than a quarter of its semiconductor revenue in fiscal 2024 -- compared to 15% of its revenue in fiscal 2023 and 10% of its revenue in fiscal 2022.
Broadcom expects its infrastructure software segment to hold steady as its revenue rises by the low-single digits year over year in the third quarter. It attributes that stable growth to its high renewal rates and successful sales of additional products to its existing customers. If Broadcom closes its acquisition of VMware, it expects to generate about half of its revenue from its infrastructure software business -- which would reduce its dependence on Apple and the cyclical semiconductor market.
Economies of scale are boosting its margins
Broadcom's scale is improving as it acquires, streamlines, and integrates more companies. That's why its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) margin expanded from 60.4% in fiscal 2021 to 63.3% in fiscal 2022, then rose to 64.4% in the first half of fiscal 2023. It expects to post an even higher adjusted EBITDA margin of 65% in the third quarter. Its free-cash-flow (FCF) margin has also stayed in the high 40s throughout those two and a half years.
Broadcom expects its total revenue to rise 5% year over year in the third quarter, while analysts anticipate 8% growth for the full year. They also expect its adjusted EBITDA to rise 7% for the full year, which would give it an adjusted EBITDA margin of about 63%. Based on those expectations, which don't even factor in its potential gains from VMware, Broadcom's stock still looks surprisingly cheap at 16 times this year's adjusted EBITDA and 19 times its forward adjusted earnings. It also pays a decent forward dividend yield of 2.3%, and it consistently spends its excess cash on big buybacks.
In short, I don't think it's too late to buy Broadcom's stock. Its rally over the past year was justified, its valuations are still low, and three major catalysts -- Apple, AI, and VMware -- could catapult the stock to fresh highs over the next few years.