Broadcom: High-Quality Semiconductor Company, But Priced For Perfection

Summary:

• Broadcom’s AI revenue is expected to exceed $10B this fiscal year, benefiting from the AI growth spurt.
• AVGO’s valuation has also surged well above its long-term average, behooving caution.
• AI revenue is expected to comprise about 20% of Broadcom’s revenue base, not the majority.
• Investors must assess AVGO stock carefully as it’s not a pure-play AI stock.
• While Broadcom is a top-notch semiconductor company, AVGO seems too expensive to turn bullish now.

Broadcom Goes All In On AI

Broadcom Inc. (NASDAQ:AVGO) investors have witnessed an extended consolidation since AVGO stock topped out at the $1,440 level in March 2024. Buyers have failed to muster more robust buying momentum over the past eight weeks. Accordingly, Broadcom reported its earnings release in March 2024. Broadcom also delivered its AI conference called “Enabling AI Infrastructure” in the same month. While Broadcom’s first fiscal-quarter earnings release and guidance were robust, AVGO suffered a post-earnings decline. Despite that, Broadcom’s AI event also bolstered Wall Street’s confidence in Broadcom’s growing AI portfolio opportunities. As a result, analysts have remained relatively sanguine about Broadcom’s AI growth inflection, even as Broadcom navigates headwinds in other areas. I highlighted my caution on AVGO even though it has continued to outperform my expectations. Therefore, AVGO buyers’ ability to defy gravity has impressed me.

Broadcom is a semiconductor bellwether, closely watched by investors and analysts for deep insights into the health of the semiconductor value chain. The company has a broad portfolio comprising “critical markets such as cloud, data center, networking, broadband, wireless, storage, industrial, and enterprise software.” Broadcom’s acquisition of VMware has augmented the company’s enterprise software opportunities. Broadcom is also expected to fully integrate VMware into its operations by the end of this year, lowering the execution headwinds from the next fiscal year.

I believe AVGO stock’s surge over the past year is mainly driven by the growth inflection of AI revenue within Broadcom’s well-diversified portfolio. Accordingly, AVGO has participated in the AI growth spurt, rising more than 110% in total returns over the past year. Broadcom anticipates AI revenue to exceed $10B this fiscal year, up from its previous estimates of $8B. In addition, it’s also expected to account for 35% of Broadcom’s semiconductor revenue for 2024, up from a previous forecast of 25%.

Consequently, Broadcom has delivered substantial confidence for investors that its AI revenue could broaden, providing a much-needed lift for less tepid growth in its enterprise and consumer segments. Despite that, it’s also critical for investors to note that Broadcom guided for $50B in total revenue for FY2024. Therefore, AI revenue is expected to account for about 20% of Broadcom’s total revenue base. Hence, investors need to carefully assess Broadcom’s AI growth drivers, as they aren’t expected to account for most of AVGO’s valuation in the near term.

AVGO Stock Is Expensive

Despite that, the market has markedly re-rated AVGO’s valuation in anticipation of its AI growth spurt. As seen above, AVGO is assigned a premium “D-” valuation grade against an overall growth grade of “B.” AVGO stock’s forward adjusted EBITDA multiple of 20.5x is well above its 10Y average of 11.5x, reflecting significant optimism.

Sure, AVGO bulls could argue that AI revenue comprised less than 5% of semiconductor revenue before 2022. As a result, investors should assess Broadcom’s AI prospects based on whether they are sustainable in the medium term.

Broadcom’s AI investor event demonstrated its AI prowess in merchant networking solutions and custom AI accelerator engagements. Broadcom reminded investors that its Ethernet AI infrastructure is critical to facilitating AI at a scale, comparing constructively with better economics against InfiniBand.

In addition, Broadcom added another strategic AI customer (possibly ByteDance) for consumer AI. Broadcom highlighted that “large-scale consumer AI companies prefer custom AI accelerators due to their efficiency and cost-effectiveness.” Consequently, Broadcom demonstrated its ability to land critical and significant consumer AI customers, underscoring the value of its “deep, strategic, and multi-year engagements.” Coupled with Broadcom’s assessment of a “limited number of key customers worldwide in the consumer AI market,” it should strengthen Broadcom’s value proposition against smaller peers.

Is AVGO Stock A Buy, Sell, Or Hold?

AVGO’s price chart doesn’t lie. The market is confident in the wide-moat semiconductor company’s ability to deliver on its AI premise. As a result, dip-buyers robustly defended steep pullbacks over the past year.

I have acknowledged that my previous caution on AVGO hasn’t paid off. Therefore, I concluded that I missed the most attractive growth phase in AVGO’s rally over the past year, which bottomed out resoundingly in October 2022.

However, I’m also wary about turning bullish on AVGO now, knowing that the market has likely reflected significant optimism in AVGO. It’s crucial to consider Broadcom’s AI revenue, which is still expected to form 20% of its total revenue base in FY2024. As a result, we mustn’t expect AVGO to be valued much higher unless Broadcom management can guide more optimistically.

Despite that, it doesn’t mean investors should short or cut their AVGO exposure significantly, as I believe Broadcom remains one of the best semiconductor stocks that money can buy.

Therefore, I will patiently wait for a possible entry opportunity between the $800 to $1,000 level to consider getting in. For now, I believe AVGO remains too expensive to justify its AI growth inflection.

Rating: Maintain Hold.

Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Consider this article as supplementing your required research. Please always apply independent thinking. Note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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