Fabless chip and software maker Broadcom (NASDAQ:AVGO) reported results above of analyst expectations in Q3 FY2022 quarter, with revenue up 24.8% year on year to $8.46 billion. Guidance for next quarter's revenue was $8.9 billion at the midpoint, which is 2.08% above the analyst consensus. Broadcom made a GAAP profit of $2.99 billion, improving on its profit of $1.87 billion, in the same quarter last year.
Broadcom (AVGO) Q3 FY2022 Highlights:
- Revenue: $8.46 billion vs analyst estimates of $8.4 billion (small beat)
- EPS (non-GAAP): $9.73 vs analyst estimates of $9.55 (1.91% beat)
- Revenue guidance for Q4 2022 is $8.9 billion at the midpoint, above analyst estimates of $8.71 billion
- Free cash flow of $4.3 billion, roughly flat from previous quarter
- Inventory Days Outstanding: 81, up from 78 previous quarter
- Gross Margin (GAAP): 75.4%, up from 74.4% same quarter last year
Originally the semiconductor division of Hewlett Packard, Broadcom (NASDAQ:AVGO) is a semiconductor conglomerate that spans wireless, networking, data storage, and industrial end markets along with an infrastructure software business focused on mainframes and cybersecurity.
Today’s Broadcom traces its roots to the chip division of Agilent Technologies, which was acquired by private equity giants KKR and Silver Lake in 2005, renamed Avago and put under the guidance of CEO Hock Tan. Since 2005, its strategy has been to acquire leading infrastructure technology providers, and improve their margins and FCF by integrating their back office and sales functions into its platform and running the businesses with an emphasis on profitability over growth at any cost.
Over time, the acquired companies diversified Broadcom’s business model and the improved free cash flow provides the capital for further acquisitions. In the past decade Hock Tan’s Avago has spent over $70 billion acquiring CYOptics, LSI, Emulex, Broadcom (whose name it adopted), Brocade, CA, and Symantec’s enterprise security business.
Broadcom’s semiconductor business provides chips used in smartphones, data centers, set top boxes, servers, telecom, and networking systems. Its software business focuses on infrastructure and security, with key businesses in database, application development, endpoint security, and identity management.Broadcom’s peers and competitors in semiconductors include Analog Devices (NASDAQ: ADI), Cisco Systems (NASDAQ: CSCO), Intel (NASDAQ:INTC), MediaTek (TWSE:2454), Marvell Technology (NASDAQ:MRVL), NXP Semiconductors NV (NASDAQ:NXPI), Qualcomm (NASDAQ:QCOM), Qorvo (NASDAQ: QRVO), and Skyworks (NASDAQ:SWKS). | Its software rivals are Atlassian (NASDAQ:TEAM), CrowdStrike (NASDAQ:CRWD), IBM (NYSE:IBM), Oracle (NYSE:ORCL), ServiceNow (NASDAQ:NOW), Splunk (NASDAQ:SPLK), and VMware (NYSE: VMW).
Processors and Graphics Chips
Chips need to keep getting smaller in order to advance on Moore’s law, and that is proving increasingly more complicated and expensive to achieve with time. That has caused most digital chip makers to become “fabless” designers, rather than manufacturers, instead relying on contracted foundries like TSMC to manufacture their designs. This has benefitted the digital chip makers’ free cash flow margins, as exiting the manufacturing business has removed large cash expenses from their business models.
Broadcom's revenue growth over the last three years has been unremarkable, averaging 12.6% annually. But as you can see below, last year has been stronger for the company, growing from quarterly revenue of $6.77 billion to $8.46 billion. Semiconductors are a cyclical industry and long-term investors should be prepared for periods of high growth, followed by periods of revenue contractions (which can sometimes offer opportune times to buy).
This was a decent quarter for Broadcom as revenues grew 24.8%, topping analyst estimates by 0.68%.
Broadcom believes the growth is set to continue, and is guiding for revenue to grow 20.1% YoY next quarter, and Wall St analysts are estimating growth 9.41% over the next twelve months.
Product Demand & Outstanding Inventory
Days Inventory Outstanding (DIO) are an important metric for chipmakers, as it reflects the capital intensity of the business and the cyclical nature of semiconductor supply and demand. In a tight supply environment, inventories tend to be stable, allowing chipmakers to exert pricing power. Steadily increasing DIO can be a warning sign that demand is weak, and if inventories continue to rise the company may have to downsize production.
This quarter, Broadcom’s inventory days came in at 81, 19 days above the five year average, suggesting that that inventory has grown to higher levels than what we used to see in the past.
Broadcom's gross profit margin, how much the company gets to keep after paying the costs of manufacturing its products, came in at 75.4% in Q3, up 1 percentage points year on year.
Gross margins have been trending up over the last year, averaging 75.1%. Broadcom's gross margins remain one of the highest in the semiconductor sector, driven strong pricing power from its differentiated chips.
Broadcom reported an operating margin of 61.4% in Q3, up 3.2 percentage points year on year. Operating margins are one of the best measures of profitability, telling us how much the company gets to keep after paying the costs of manufacturing the product, selling and marketing it and most importantly, keeping products relevant through research and development spending.
Operating margins have been trending up over the last year, averaging 60.4%. Broadcom's margins remain one of the highest in the semiconductor industry, driven by its highly efficient operating model's economies of scale.
Earnings, Cash & Competitive Moat
Analysts covering the company are expecting earnings per share to grow 15.7% over the next twelve months, although estimates are likely to change post earnings.
Earnings are important, but we believe cash is king as you cannot pay bills with accounting profits. Broadcom's free cash flow came in at $4.3 billion in Q3, up 25.7% year on year.
Broadcom has generated $15.3 billion in free cash flow over the last twelve months, translating to 48.3% of revenues. This is a great result; Broadcom's free cash flow conversion was very high compared to most semiconductor companies, in the last year. This high cash conversion, if maintained, puts it in a great position to invest in new products, while also remaining resilient during industry down cycles.
Over the last 5 years Broadcom has averaged a 17.3% return on invested capital (ROIC), implying it has a very healthy competitive position and a track record of investing in profitable growth.
Key Takeaways from Broadcom's Q3 Results
Sporting a market capitalization of $201 billion, more than $9.97 billion in cash and with positive free cash flow over the last twelve months, we're confident that Broadcom has the resources it needs to pursue a high growth business strategy.
Broadcom's revenue guidance for the next quarter looks quite a bit better than what the analysts were expecting. And we were also glad to see that earnings outperformed analysts' expectations. On the other hand, there was an increase in inventory levels. Zooming out, we think this was still a decent, albeit mixed, quarter, showing the company is staying on target. The company currently trades at $480.5 per share.
Is Now The Time?
When considering Broadcom, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. We think Broadcom is a good business. However, its revenue growth has been weak, and analysts expect growth rates to deteriorate from there. But on a positive note, its powerful free cash generation enables it to sustainably invest in growth initiatives while maintaining an ample cash cushion, and its impressive gross margins are indicative of robust pricing power.
Broadcom's price to earnings ratio based on the next twelve months is 12.3x. There is definitely a lot of things to like about Broadcom and looking at the semiconductors landscape right now, it seems that it doesn't trade at an unreasonable price point.
The Wall St analysts covering the company had a one year price target of $672.7 per share right before these results, implying that they saw upside in buying Broadcom even in the short term.
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