Broadcom: Strong Competitive Positioning in Tech

I am neutral on Broadcom (AVGO) as its strong competitive positioning and strong growth and profitability momentum are largely offset by its valuation multiples, which currently trade at a premium to its recent historical averages.

AVGO is a semiconductor technology company with a well-diversified product portfolio. It offers software products via its Brocade, CA Technologies, and Symantec enterprise security acquisitions, as well as radio frequency filters, amplifiers, and semiconductors, among other hardware products.

In this article, I will lay out two reasons to like AVGO stock, along with a look at the valuation which prevents me from being bullish here.

Robust Q1 Results

AVGO recently reported impressive Q1 results which showed revenue soaring by 16% year-over-year to over $7.7 billion, diluted earnings per share of $8.39, and a whopping free cash flow sum of nearly $3.4 billion.

The company passed along these impressive results to shareholders via a $4.10 dividend, and approximately $3.1 billion in shares repurchased.

The strong growth was largely driven by Semiconductor Solutions (up 20% year-over-year), Server Storage Connectivity (up 32% year-over-year), and Networking Products (up 33% year-over-year). Wireless and Infrastructure Software revenue remained solid, with 5% year-over-year growth in each segment.

Management thinks that the strong momentum will continue moving forward, with guidance for sequential growth to $7.9 billion in revenue in Q2.

Analysts also have bullish expectations for the company’s near-term outlook, expecting revenue to grow by 16.7% in 2022, and by 6.1% in 2023.

EBITDA is expected to soar by 20.8% in 2022, and 6.4% in 2023, and earnings per share are expected to grow by 26.8% this year, and by 9.1% in 2023.

The dividend should also continue to see solid double-digit annualized growth in the years to come, with a hike of 14% expected in 2022, and an increase of 9.8% expected in 2023.

Strong Competitive Positioning

AVGO’s skill at designing chips for networking switching and RF bulk acoustic resonator filters makes it a difficult company to compete with. It has also established formidable scale across many other products areas, including Wi-Fi chips and enterprise storage chips.

AVGO further strengthens its competitive positioning through meaningful investments in research and development, which it is able to balance with a focus on free cash flow generation and shareholder returns.

Last, but not least, it regularly makes strategic acquisitions to increase its intellectual property advantage and technical capabilities, while also boosting scale and unlocking synergies in strategic industries.

Slightly Overvalued

While the company is clearly firing on all cylinders, and is expected to continue doing so for the foreseeable future, the valuation is not particularly opportunistic.

Its current EV/EBITDA multiple is 12.5 compared to its five-year average of 11.2. Its current price-to-normalized earnings ratio is 15 compared to its five-year average of 14.2.

Last, but not least, its price-to-free cash flow ratio is 13.4 compared to its five-year average of 13.

Each of these valuation metrics imply that investors are not getting any margin of safety when buying shares at current prices, and that the company will need to continue outperforming in order to justify the current lofty valuation.

According to Wall Street analysts, AVGO earns a Strong Buy analyst consensus based on 12 unanimous Buy ratings over the past three months.

The average analyst AVGO price target of $711.67 puts the upside potential at 23.5%.

Summary and Conclusions

AVGO enjoys a strong competitive position in its industry, and is bolstered by its strong technological prowess, and economies of scale. It’s only growing stronger over time as management continues to invest in research and development, as well as strategic acquisitions to unlock new synergies, boost technological capabilities, and further diversify revenue streams.

AVGO is no longer just a semiconductor chip company, but is increasingly becoming a software business with recurring revenue streams.

On top of that, management has proven to be very shareholder friendly, balancing growth investments with strong free cash flow generation, and substantial dividend growth and share buybacks.

Despite the strong momentum in the industry and business, the valuation currently looks a bit rich, even after the recent pullback in the share price.

While analysts are unanimously bullish on the stock here and assign it a price target that implies decent upside, the lack of a margin of safety across a multitude of valuation multiples could serve as a cautionary sign for investors.

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