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Broadcom (NASDAQ:AVGO) Q2 Sales Beat Estimates, Guides For Strong Sales Next Quarter


Full Report / June 27, 2022
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Fabless chip and software maker Broadcom (NASDAQ:AVGO) announced better-than-expected results in the Q2 FY2022 quarter, with revenue up 22.5% year on year to $8.1 billion. Guidance for next quarter's revenue was $8.4 billion at the midpoint, 5.37% above the average of analyst estimates. Broadcom made a GAAP profit of $2.59 billion, improving on its profit of $1.49 billion, in the same quarter last year.

Broadcom (AVGO) Q2 FY2022 Highlights:

  • Revenue: $8.1 billion (2.46% beat)
  • EPS (non-GAAP): $9.07 vs analyst estimates of $8.72 (4.06% beat)
  • Revenue guidance for Q3 2022 is $8.4 billion at the midpoint, above analyst estimates of $7.97 billion
  • Free cash flow of $4.15 billion, up 22.8% from previous quarter
  • Inventory Days Outstanding: 78, up from 72 previous quarter
  • Gross Margin (GAAP): 75.8%, up from 74.2% 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 unremarkable, averaging 11.3% annually. But as you can see below, last year has been stronger for the company, growing from quarterly revenue of $6.61 billion to $8.1 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 decent quarter for Broadcom as revenues grew 22.5%, topping analyst estimates by 2.46%.

Broadcom believes the growth is set to accelerate, and is guiding for revenue to grow 23.9% YoY next quarter, and Wall St analysts are estimating growth 11.2% 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 78, 16 days above the five year average, suggesting that that inventory has grown to higher levels than what we used to see in the past.

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 75.8% in Q2, up 1.6 percentage points year on year.

Broadcom Gross Margin (GAAP)

Gross margins have been trending up over the last year, averaging 74.8%. 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 60.9% in Q2, up 3.4 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 59.6%. 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 18.1% 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 $4.15 billion in Q2, up 20.7% year on year.

Broadcom Free Cash Flow

Broadcom has generated $14.4 billion in free cash flow over the last twelve months, translating to 48% 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 17.1% 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 Q2 Results

Sporting a market capitalization of $217 billion, more than $9 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.

We were impressed by the very optimistic revenue guidance Broadcom provided for the next quarter. And we were also excited to see that earnings outperformed Wall St’s expectations. On the other hand, it was less good to see the inventory levels increase. Overall, this quarter's results seemed pretty positive and shareholders can feel optimistic. The company currently trades at $550 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 14.7x. 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 $696.6 per share right before these results, implying that they saw upside in buying Broadcom even in the short term.

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