Shares of Broadcom (AVGO 4.11%) rallied 17.2% this week through Thursday trading, according to data from S&P Global Market Intelligence.
The semiconductor giant, which just closed on a transformative acquisition of software giant VMware at the end of November, reported its fiscal fourth-quarter earnings last week.
Apparently, analysts liked what they heard, and raised their price targets on the stock accordingly.
NASDAQ: AVGO
Key Data Points
AI tailwinds and a massive lift from VMware
On Monday, Citi analyst Christopher Danely raised his price target on Broadcom to $1,100, giving the company a buy rating. This might seem strange as Broadcom has already exceeded that price target, but at the beginning of this week, the stock was only trading around $950.
While many stocks did well this week in the wake of the Federal Reserve's Wednesday meeting and outlook for interest rate cuts next year, Broadcom's rally started right away on Monday in the wake of this analyst note.
So, it appears Danely's thesis resonated. That thesis includes a robust outlook for artificial intelligence (AI) networking chips, which Danely believes will double for Broadcom in 2024 from $4 billion to $8 billion in revenue. Danely is also bullish on the VMware acquisition, which closed Nov. 22. In fact, Danely quantifies his earnings expectations for that asset. Danely believes VMware could add $12.50 to Broadcom's earnings per share in the coming year. For reference, Broadcom just printed $42.25 in adjusted (non-GAAP) earnings per share (EPS) in fiscal 2023, so the incremental contribution from VMware would be about 30% in that scenario.
How can VMware generate such profitability when VMware didn't generate much profit prior to the acquisition? Well, Broadcom has embarked on a rather aggressive round of layoffs since closing the deal in November. While the ultimate number isn't yet known, according to Worker Adjustment and Retraining Notification (WARN) notices filed with several states, it appears at least 2,837 layoffs are coming, and likely more over time. On the conference call with analysts last week, CEO Hock Tan said the plan is to refocus VMware on its core hybrid and private cloud software business, while divesting noncore assets.
This is of course unfortunate news for employees, but it's also likely VMware wasn't running very efficiently in recent years. Moreover, Broadcom has a history of successful acquisitions, with a formula that usually includes cutting excess corporate overhead, folding the company into Broadcom's existing structure, and then reinvesting in focused growth.
The enthusiasm extended to Tuesday, when Bank of America analyst Vivek Arya also gave Broadcom a buy rating while increasing his price target to $1,250 from $1,200. His analysis was along the same lines as Citi's. And both analysts put out a rough earnings target of $60 in EPS next year, which would put Broadcom's valuation a tad over 18 times 2024 earnings today.
Broadcom has a big AI opportunity
Given increased intensity on networking that will be needed in AI data centers, Broadcom appears to have strong growth ahead, at least in its data center infrastructure business. But even that may be enough to justify today's valuation.
After all, a doubling of the company's networking revenue alone, or an incremental $4 billion, would amount to over 11% organic growth for the whole company, which made $35.8 billion in the recently completed year. So even if its other markets in communications and broadband infrastructure are flat, that would still be a decent performance.
All in all, Broadcom remains a reasonably priced dividend growth stock for defensive investors in the semiconductor sector.
