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Broadcom (NASDAQ:AVGO) Reports Q3 In Line With Expectations, Provides Encouraging Quarterly Guidance


Full Report / November 02, 2021
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Fabless chip and software maker Broadcom (NASDAQ:AVGO) reported results in line with analyst expectations in Q3 FY2021 quarter, with revenue up 16.4% year on year to $6.77 billion. Guidance for next quarter's revenue was $7.35 billion at the midpoint, which is 1.53% above the analyst consensus. Broadcom made a GAAP profit of $1.87 billion, improving on its profit of $688 million, in the same quarter last year.

Broadcom (AVGO) Q3 FY2021 Highlights:

  • Revenue: $6.77 billion vs analyst estimates of $6.75 billion (small beat)
  • EPS (non-GAAP): $6.96 vs analyst estimates of $6.91 (small beat)
  • Revenue guidance for Q4 2021 is $7.35 billion at the midpoint, above analyst estimates of $7.23 billion
  • Free cash flow of $3.42 billion, roughly flat from previous quarter
  • Inventory Days Outstanding: 61, up from 54 previous quarter
  • Gross Margin (GAAP): 74.4%, up from 73.5% same quarter last year

Originally the semiconductor division of Hewlett Packard, and its today’s form a result of a series of mergers and acquisitions, 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).

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 slow, averaging 9.5% annually. But as you can see below, last year has been stronger for the company, growing from quarterly revenue of $5.82 billion to $6.77 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 an OK quarter for Broadcom with revenues growing 16.4%, ahead of analyst estimates.

Broadcom believes the growth is set to accelerate, and is guiding for revenue to grow 26.2% YoY next quarter, and Wall St analysts are estimating growth 7.33% 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.

Broadcom Inventory Days Outstanding

This quarter, Broadcom’s inventory days came in at 61, one day below the five year average, showing that despite the recent increase there is no indication of an excessive inventory buildup at the moment.

Pricing Power

Broadcom's gross profit margin, how much the company gets to keep after paying the costs of manufacturing its products, came in at 74.4% in Q3, up 0.9 percentage points year on year.

Broadcom Gross Margin (GAAP)

Gross margins have been trending up over the last year, averaging 73.6%. Broadcom's gross margins remain one of the highest in the semiconductor sector, driven strong pricing power from its differentiated chips.

Profitability

Broadcom reported an operating margin of 58.2% in Q3, up 3.6 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.

Broadcom Adjusted Operating Margin

Operating margins have been trending up over the last year, averaging 57.3%. 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 11.5% over the next twelve months.

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 $3.42 billion in Q3, up 11.4% year on year.

Broadcom Free Cash Flow

Broadcom has generated $13.1 billion in free cash flow over the last twelve months, translating to 49.4% of revenues. This is a great 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 14.1% return on invested capital (ROIC), implying it has has a defensible competitive position and can invest in profitable growth.

Key Takeaways from Broadcom's Q3 Results

With a market capitalization of $217 billion, more than $11.1 billion in cash and with free cash flow over the last twelve months being positive, the company is in a very strong position to invest in growth.

It was good to see Broadcom provide next quarter revenue outlook exceeding analysts’ expectations. And we were also glad to see the improvement in operating margin. On the other hand, it was less good to see the inventory levels increase and the revenue growth was quite weak. Overall, this quarter's results could have been better. The company currently trades at $528.05 per share.

Is Now The Time?

Although we have other favorites, we understand the arguments that Broadcom is not a bad business. However, its revenue growth has been very weak, and analysts expect growth rates to slow down again after the recent acceleration. But on a positive note, its powerful free cash generation enables it to sustainably invest in growth initiatives while maintaining an ample cash cushion.

Broadcom's price to earnings ratio based on the next twelve months is 17.9x. We don't really see a big opportunity in the stock at the moment, but in the end beauty is in the eye of the beholder. And if you like the company, it seems that Broadcom doesn't trade at a completely unreasonable price point.

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