broadcom AVGO announced its third quarter financial results on December 12th. Here's Morningstar's take on Broadcom's earnings and stock price:
Morningstar Key Metrics for Broadcom
Thoughts on Broadcom's third quarter results
Broadcom reported revenue of $14.1 billion for the October quarter, up 8% from the previous quarter. Longer term, management estimates the viable market size for artificial intelligence chips at its three largest customers to be between $60 billion and $90 billion in fiscal 2027.
- Conclusion: We also raised our fair value estimate for Broadcom from $155 to $190 per share as we raised our AI revenue growth forecast for the company. We now view the stock, which rose 15% in after-hours on strong earnings and guidance, to be about fair value.
- Broadcom currently projects annual AI chip sales to increase by nearly 40% through fiscal 2029 and include more than 50% annual growth through fiscal 2027. This places us at the conservative end of management's SAM. We model AI chip revenue to be $44.2 billion in 2027.
- We believe that to buy Broadcom stock today, investors must believe in the midpoint or upper end of management's SAM and expect Broadcom to retain a 70% share of this opportunity.
- Why it's important: Broadcom's FY2027 SAM forecast suggests AI revenue growth over the next three years will be significantly higher than our expectations, with an annualized rate of approximately 62% starting in FY2024.
- We believe Broadcom has a path to acquiring a majority share of this SAM in the future. Management estimates SAM in FY2024 to be between $15 billion and $20 billion, which means Broadcom will have about a 70% share of AI chip sales of $12.2 billion in FY2024. are.
- Given that Broadcom has begun working with two more custom AI accelerator customers (likely Apple AAPL and OpenAI) to sell merchant networking chips for AI to a broader customer base. , we believe there is potential upside to management's SAM.
- Big picture: Broadcom's impressive AI revenue outlook reflects the company's long-term belief that it has differentiated chip design capabilities for high-performance networking and computing that can leverage significant cloud investments and gain market share. It's based on a hypothesis.
Broadcom Fair Value Estimate
With a 2-star rating, we believe Broadcom stock is overvalued compared to our long-term fair value estimate of $190 per share. Our valuation is for FY2025 adjusted price/earnings ratio of 30x and FY2025 enterprise value to sales multiple of 15x.
In our view, Broadcom's key valuation factors are the growth of its AI chip business and its ability to extract growth and operating leverage from VMware. We also expect continued inorganic growth over the long term. We model Broadcom's revenue to grow 18% by fiscal 2029. While artificial intelligence sales will drive extraordinary growth over the next five years, we expect long-term sustainable growth to settle at around 10% organically.
Learn more about Broadcom's fair value estimates here.
Evaluation of economic moat
We believe Broadcom has a wide moat due to chip design intangibles and software product switching costs. The company's strengths in both chips and software mean it has strong accounting and economic returns, and its competitive position will allow it to do so for the next 20 years. Most of the company's business is in semiconductors, with a broad range of end markets across enterprise networking, wireless chips for smartphones, broadband access, and storage applications. Here we see the two biggest exposures are networking and wireless chips, benefiting from the company's expertise in chip design.
Most of Broadcom's business is in semiconductors, with exposure to a wide range of end markets across enterprise networking, wireless chips for smartphones, broadband access, and storage applications. We see that the two biggest exposures here, networking chips and wireless chips, benefit from the company's extensive expertise in chip design.
Read more about Broadcom's economic moat.
financial strength
We expect Broadcom to focus on strong cash generation. In the short term, the company is expected to focus on repaying the debt it incurred for the VMware acquisition. In the long term, we expect to focus on increasing dividends and further acquisitions to increase cash flow. As of October 2024, Broadcom had $9 billion in cash and equivalents against total debt of $68 billion, about half of which was used to fund the 2023 acquisition of VMware. We are not concerned about our debt burden, given the long shelf life of our outstanding bonds and solid cash generation. After the VMware acquisition, Broadcom's total debt/adjusted EBITDA ratio increased to 3.5x, but the company ended fiscal 2024 with that number dropping to 2.1x.
Learn more about Broadcom's financial strength.
risk and uncertainty
We assign Broadcom a medium uncertainty rating. As a chip manufacturer, the company is subject to market demand and supply cycles. While our software exposure and networking strengths have helped us offset business cycles in recent years, future cycles may not be the same. The company also relies heavily on Taiwan Semiconductor Manufacturing Co., Ltd. (TSM) for chips, and supply constraints could prevent shipments to customers. Nevertheless, we believe that Broadcom is a priority customer of Taiwan Semiconductor and would be given high priority in such a scenario due to both its size and long-term relationship.
Learn more about Broadcom's risks and uncertainties here.
AVGO Bulls Say
- Broadcom is the epitome of operational efficiency. Earn excellent operating profit margins and generate huge cash flow. We are particularly strong in corporate acquisitions and reducing unnecessary expenses.
- Broadcom's networking and wireless chip business boasts best-in-class technology, along with strong customer relationships with Apple AAPL, Alphabet, Cisco Systems CSCO, Arista Networks ANET, and more.
- We believe Broadcom will greatly benefit from increased AI spending, which is expected to drive significant growth in network semiconductor sales.
AVGO Bears Say
- Broadcom has significant exposure to businesses outside of MOAT, including broadband and storage chips.
- Broadcom's software portfolio includes many legacy and mature businesses, such as virtualization and mainframe, that are considered to have lower growth rates.
- Broadcom relies heavily on acquisitions to expand its portfolio, but it tends to focus on cost reductions rather than pursuing strategic synergies in deals.
This article was edited by Kaylee Hall.
