On Seeking Alpha and on my social media channels, I focus very heavily on US and Chinese tech names that have significant media coverage. A relatively discreet company but which occupies an important place in the health of the technological rebound is Broadcom (NASDAQ: AVGO). I believe that any sustainable Nasdaq rally (QQQ) must be accompanied by resistance in the semiconductors. And inside the SOXX semiconductor ETF, Broadcom is the 2nd largest component.
In this article, I’ll explain why I think Broadcom’s outlook continues to be positive and what their latest fundamental updates mean for the semiconductor industry and the technology rebound we’re currently seeing.
Broadcom Quick Introduction and High Level Investment Background
In one sentence to describe Broadcom, the company is essentially a semiconductor industry conglomerate, providing support in data centers, wireless infrastructure, broadband, and networking services. A sample list of its biggest customers includes Apple, HP, IBM, FB, GOOG and Cisco, where Broadcom provides custom data center services that often have little choice for substitutes.
During the tech sell-off in the first quarter of 2022, Broadcom shares fell significantly, along with other growth-themed semiconductor names and stocks.
In today’s market, where many names have very rich valuations or have business models susceptible to high inflation and low consumer confidence, Broadcom is one of the few S&P 500 companies that offers significant diversification of its business model while being relatively insulated from the inflationary narratives currently facing markets.
In addition to its strong growth profile, Broadcom also offers investors a 2.6% yield, giving it the rare title of being a growth aggregator and a dividend growth stock.
Broadcom’s Latest Fundamental Insights
Due to tight supply chain dynamics (due to China’s zero covid policy), Broadcom’s semiconductor backlog grew 14% quarter over quarter and the company guided Q2 2022 revenue by $7.9 billion above consensus of $7.42 billion on strong growth in semiconductors and stable infrastructure software.
Looking to its outlook for 2023, the company expects positive growth with strong order visibility and backlog of $25 billion (up 14% quarter-over-quarter and 119% up). year-over-year), given that business spending is still strong on cloud and broadband.
As a result, the company expects to generate approximately 20% revenue growth throughout 2022. Seeing 30% year-over-year growth, its networking business continues to experience strong demand for its products (Tomahawk 4 / Jericho 2). Additionally, the company’s ASIC chip business with Google, Facebook and Microsoft continues to be very robust and the FAAMG companies’ continued commitment to corporate spending is a tailwind for Broadcom. The company’s infrastructure software revenue of $1.8 billion increased 5% year-over-year, driven by strong recurring revenue and rates high turnover. This translates to a higher gross margin of 75.5% above consensus, as well as EPS of $8.39 above consensus of $8.13.
CEO Hock Tan continues to remain modest in his forecast of the industry and has cooled expectations of a change in the industry’s long-term growth rates despite growing use cases for silicon to be used on a variety of end markets. He and the management team reiterated their support for shareholder returns and repurchased $2.7 billion in stock.
Latest Industry Trends and Commentary on Semiconductors
Semiconductor industry data WSTS was recently released for February 2022. We saw February industry sales accelerating to nearly 48% year-over-year (~25 % if you exclude memory). The report notes strong industry pricing (35% year-over-year) driven by strong end-market demand coupled with tight supply dynamics. The report is in line with Micron’s latest quarterly outlook, in which the company discussed strong demand and pricing in its DRAM and NAND markets.
Specifically, here are some additional data points from the WSTS report:
Month-over-month February sales increased 23%
Year-over-year prices were 35% higher
Unit shipments decreased 2% month-over-month, but increased 11% year-over-year
This industry data supports the narrative that demand continues to be strong while supply chain issues are ones that will take even longer to resolve.
Broadcom is an exceptionally large component in SOXX and Nasdaq 100
Broadcom doesn’t get as much media coverage as traditional newsletter stocks, but it would be wise to put this name on your watch list as it’s a bellwether for the semiconductor industry. Historically speaking, any sustainable rebound in the tech sector is usually led by the Chips. I specifically focus on the health of AMD, NVDA, AMAT, LRCX, MU and AVGO to understand broader industry trends.
Broadcom is No. 9 in the Nasdaq 100 and No. 2 in the ETF Semiconductor SOXX. In other words, a positive fundamental outlook for Broadcom adds credibility to the tech rebound we’ve seen. Although I’m a fan of Tesla (the hottest retail stock that I unfortunately don’t own), hot retail stocks like Tesla can’t drive a lasting bounce inside the Nasdaq.
I view Broadcom’s business model with its B2B end markets as much more representative of enterprise spend and give us clues about the R&D appetites of mega cap names like AAPL, FB, GOOG and MSFT. Broadcom’s weak outlook portends declining confidence in business spending, which accounts for a significant portion of business activity at Nasdaq-listed companies.
On the Fed’s rate hike, valuation and recession fears
Broadcom’s valuation has never been cheap in the market given its leading position in the market. While there are many ways to value the business, I almost always use simpler metrics like earnings or sales multiples.
On a sell multiple, Broadcom trades at around 9.4 times sells. On the surface, that seems expensive given the hawkish environment we find ourselves in. Compared to other high valuation stocks like ZM (9.2X) or PINS (7.3X) for example, Broadcom’s valuation is not considered expensive given their market. -leading position as well as their strong momentum in end market demand.
I believe we are in an environment where picking market leaders with exceptionally strong business models will lead to better risk-adjusted returns. Given where we are in the economic cycle, with the yield curve having flattened and inflation making the Fed more hawkish, Broadcom is the type of company profile tech investors should consider and put on their bucket list. oversight given their strong fundamental profile (if they don’t have a position yet).
I recently ran a poll on the Community tab of my YouTube channel. Out of 2,800 retail investors, only 26% believe there will be no recession. Coupled with publicly available economic data (PMI, Consumer Confidence, Yield Curve Inversion), the retail market has essentially convinced itself that a recession is inevitable. For this reason, it is particularly important to position yourself in names that have sustainable and diversified business models and strong sectoral prospects.
I only have a very small position in Broadcom and will be looking to slowly and strategically buy more Broadcom stock should the market break down again.
Impressively enough, AVGO never even broke its 200-day moving average when selling the tech in the first quarter of 2022. Its 50-day moving average is in the price range of 590-600/share. I will most likely add modestly to my positions if AVGO approaches these levels.
Risks to Consider and Final Thoughts
Broadcom CEO Hock Tan reiterated that market participants should not be too quick to fundamentally reassess the industry growth rate CAGR significantly higher, given that the semiconductor industry is potentially close to a cyclical peak with signs of maturity in several end markets.
As the supply chain shortage begins to resolve itself, Broadcom and other semiconductor companies must manage their inventory and lead times with great execution or risk distorting supply/demand dynamics, which could have an impact on future prices.
From a company-specific perspective, Broadcom is less affected by the usual cyclical themes inherent in the semiconductor industry like Micron with memory prices as an example. Broadcom’s reach in segments such as broadband, data center, networking and wireless essentially makes it a market-wide proxy for enterprise spending. Observing a weaker appetite for business spending and R&D investment levels will help investors understand Broadcom’s outlook.
Broadcom’s combined growth profile, diversified business model and dividend growth prospects make a strong case for investors looking for growth companies with the right characteristics in today’s investment environment.