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Broadcom (NASDAQ:AVGO) Reports Q4 In Line With Expectations, Inventory Levels Improve


Full Report / December 07, 2023

Fabless chip and software maker Broadcom (NASDAQ:AVGO) reported results in line with analysts' expectations in Q4 FY2023, with revenue up 4.3% year on year to $9.30 billion. On the other hand, the company's full-year revenue guidance of $50 billion at the midpoint came in 2.1% below analysts' estimates. It made a GAAP profit of $8.25 per share, down from its profit of $8.80 per share in the same quarter last year.

Broadcom (AVGO) Q4 FY2023 Highlights:

  • Revenue: $9.30 billion vs analyst estimates of $9.28 billion (small beat)
  • EPS (non-GAAP): $11.06 vs analyst estimates of $10.96 (small beat)
  • Management's revenue guidance for the upcoming financial year 2024 is $50 billion at the midpoint, missing analyst estimates by 2.1% and implying 39.7% growth (vs 4.1% in FY2023)
  • Free Cash Flow of $4.72 billion, similar to the previous quarter
  • Inventory Days Outstanding: 60, down from 74 in the previous quarter
  • Gross Margin (GAAP): 68.9%, down from 73.4% in the 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. Read More The semiconductor industry is broadly divided into analog and digital semiconductors. Digital chips are what most people think of as the brains of almost every electronic device. Their primary purpose is to either store (memory chips) or process (CPUs/GPUs) data. Digital chips derive their processing power from the number of transistors that can be packed on an individual chip. In chip design, nanometers or “nm” refers to the length of a transistor gate – the smaller the gate the more processing power that can be packed into a given space. In 1965, Intel’s founder Gordon Moore famously predicted a doubling of transistors on a chip every two years. The concept, known as Moore’s Law, was based on his belief that the technology used to create semiconductors would improve continuously, allowing chips to become ever smaller and ever more powerful.

Sales Growth

Broadcom's revenue growth over the last three years has been mediocre, averaging 13.5% annually. As you can see below, this was a weaker quarter for the company, with revenue growing from $8.92 billion in the same quarter last year to $9.30 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).

Broadcom Total Revenue

This was a sluggish quarter for the company as its revenue dropped 4.3% year on year, in line with analysts' estimates. Broadcom's growth, however, flipped from negative to positive this quarter. This encouraging sign will likely be welcomed by shareholders.

Product Demand & Outstanding Inventory

Days Inventory Outstanding (DIO) is an important metric for chipmakers, as it reflects a business' capital intensity 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.

Broadcom Inventory Days Outstanding

This quarter, Broadcom's DIO came in at 60, which is 4 days below its five-year average. At the moment, these numbers show no indication of an excessive inventory buildup.

Pricing Power

In the semiconductor industry, a company's gross profit margin is a critical metric to track because it sheds light on its pricing power, complexity of products, and ability to procure raw materials, equipment, and labor. Broadcom's gross profit margin, which shows how much money the company gets to keep after paying key materials, input, and manufacturing costs, came in at 68.9% in Q4, down 4.4 percentage points year on year.

Broadcom Gross Margin (GAAP)

Gross margins have been trending down over the last year, averaging 73.2%. However, Broadcom's elite margins are some of the best in the semiconductor industry, driven by strong pricing power from its differentiated, value-add products.

Profitability

Broadcom reported an operating margin of 61.8% in Q4, up 0.1 percentage points year on year. Operating margins are one of the best measures of profitability because they tell us how much money a company takes home after manufacturing its products, marketing and selling them, and, importantly, keeping them relevant through research and development.

Broadcom Adjusted Operating Margin

Broadcom's operating margins have been trending up over the last year, averaging 61.8%. On top of that, the company's margins are some of the highest in the semiconductor industry, driven by its highly efficient operating model and economies of scale.

Earnings, Cash & Competitive Moat

Analysts covering Broadcom expect earnings per share to grow 16.2% over the next 12 months, although estimates will likely change after earnings.

Although earnings are important, we believe cash is king because you can't use accounting profits to pay the bills. Broadcom's free cash flow came in at $4.72 billion in Q4, up 5.9% year on year.

Broadcom Free Cash Flow

As you can see above, Broadcom produced $17.63 billion in free cash flow over the last 12 months, an eye-popping 49.2% of revenue. This is a great result; Broadcom's free cash flow conversion places it among the best semiconductor companies and, if sustainable, puts the company in an advantageous position to invest in new products while remaining resilient during industry downturns.

Broadcom's average return on invested capital (ROIC) of just 19.5% over the last 5 years is fairly low compared to other semiconductor companies. This underperformance suggests that the company tied up a lot of capital to achieve grow or maintain profits.

Key Takeaways from Broadcom's Q4 Results

Sporting a market capitalization of $373 billion, more than $14.19 billion in cash on hand, and positive free cash flow over the last 12 months, we believe that Broadcom is attractively positioned to invest in growth.

We were impressed by Broadcom's strong improvement in inventory levels. We were also happy its adjusted EBITDA and EPS outperformed Wall Street's estimates. On the other hand, its full-year FY24 revenue guidance underwhelmed, but it expects higher adjusted FY24 EBITDA profitability, partly thanks to its acquisition of software company VMware, which closed in November. Overall, the results could have been better. The company is down 2% on the results and currently trades at $901.55 per share.

Is Now The Time?

Broadcom may have had a bad quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.

There are numerous reasons why we think Broadcom is one of the best semiconductor companies out there. Its revenue growth has been mediocre over the last three years, but at least its growth over the next 12 months is expected to exceed that. On a positive note, however, its powerful free cash generation enables it to sustainably invest in growth initiatives while maintaining an ample cash cushion, and its impressive gross margins indicate robust pricing power.

Broadcom's price-to-earnings ratio based on the next 12 months is 18.7x. Looking at the semiconductors landscape today, Broadcom's qualities really stand out, and we really like it at this price.

Wall Street analysts covering the company had a one-year price target of $1,005.3 per share right before these results, implying that they saw upside in buying Broadcom even in the short term.

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