2023-05-31 17:23:01 ET
Summary
- There's a confluence of 3 factors that will need to be put in place for AI to flourish. The right technology, cheap energy, and infrastructure.
- Out of all the potential semiconductor players, here's why I chose Broadcom Inc.
- Broadcom is about to report results this Thursday, June 1, after hours, stay tuned.
Investment Thesis
Broadcom Inc. ( AVGO ) is a cheaply valued beneficiary of artificial intelligence, or AI, demand. As I explain in this analysis, the reason why I'm seeking to invest in this semiconductor company is that I believe that AI demand will dramatically increase, but I'm not interested in paying up for the exposure.
Broadcom is a top fit for my vision of how AI will experience significant increases in computing power and productivity with the need for networking capabilities to connect them.
By my estimates, Broadcom is priced at 16x next year's fiscal 2024 free cash flow. As far as the semiconductor space goes, this is not an expensive valuation.
In one sentence, this is the pitch, Broadcom's revenues from generative AI-supporting switches that are responsible for high bandwidth capacity and fast data transmission are going to dramatically grow in the next 12 months. And very few investors are appreciating this.
Why Broadcom? Why Now?
The more I read up about AI, the more I believe that demand for AI infrastructure will come up against the physical world.
There's a confluence of 3 factors that will need to be put in place for AI to flourish. The right technology, energy, and infrastructure.
Picking the right technology to win will be where the majority of the gains will be found in the stock market. But picking out the winner will only be easy after the fact. After the fact, it will be absolutely obvious what stock was the winning technology stock to back. So that's not realistic for us at this moment.
As for the need for energy and electrification, I'm already heavily invested in this space. From natural gas and uranium producers to a copper manufacturing company. The world is set to decarbonize our energy supply, while at the same time massively ramping up the need for energy, from EVs to AI computing and household heat generation with electricity.
This leaves me with one final characteristic that I'm interested in gaining exposure to. The infrastructure that will enable AI to be broadly adopted by consumers and enterprises alike.
By leveraging its expertise in semiconductor solutions, Broadcom can contribute to the adoption of AI by enabling faster AI processing and improved capabilities.
Broadcom can develop and provide specialized hardware components, such as processors and chips, optimized for AI applications. These components can deliver higher performance, energy efficiency, and processing capabilities required for AI workloads.
Obviously, the primary winner in this space is Nvidia Corporation ( NVDA ). But Nvidia has already rallied so hard, that I'm not sure if there's any space left for more upside.
As noted above, Broadcom is expected to report this Thursday, June 1, post-market. I'm not expecting to see any positive results from Broadcom this earnings report. In fact, I believe that weaknesses in its wireless and storage could disappoint. This insight would largely be a similar story to what we've seen with Applied Materials, Inc. ( AMAT ) and Marvell Technology, Inc. ( MRVL ) that have already been reported.
So, at the core of the reason why I'm so interested in investing in Broadcom is the need for significantly more AI Ethernet switches. Consider this quote that Broadcom previously articulated together with its Q1 2023 results .
[...] In 2022, we estimated our Ethernet switch shipments deployed in AI was over $200 million.
With the expected exponential demand from our hyperscale customers, we forecast that this could grow to well over $800 million in 2023. We anticipate this trend will continue to accelerate and mindful that we need even more higher performance networks in the future.
Think about this. Over the past 12 months, the demand for Ethernet switches for deployment in AI is up 4x. And that comment was made before all this AI hype came into the fray .
Consequently, I strongly believe that there are ample ways that the highly diversified Broadcom can further positively surprise its investors over the next 12 months. Investors will soon look to Broadcom as more than just a rapidly growing M&A company.
On top of this, recent news that Apple Inc. ( AAPL ) decided to renew its contract with Broadcom further removes one key overhang for the stock. Indeed, note that Apple generates about 20% of Broadcom's revenues. It's not a rapidly growing revenue stream. Rather, it's just one more risk factor that is no longer hanging over the stock.
Next, let's turn our focus to Broadcom's financials.
Revenue Growth Rates Appear to be Maturing
Again, as I've already stated throughout, Broadcom is not a fast-growing business. Nobody looking at Broadcom today is thinking about this business as a direct beneficiary of AI demand, after all, its growth rates for fiscal Q2 2023 point to mid-single digits. That's not commensurate with an AI story stock, as I'm confident you'll agree.
Meanwhile, analysts following the stock are not bearish on the name, as you can see below.
As an investor, I consistently make the case that you want analysts to slowly and steadily upgrade their financial models. You don't want to invest in a stock where you are having to fight against sell-side analysts.
Valuation 19x This Year's Free Cash Flow
As touched on throughout, Broadcom will report its fiscal Q2 results this Thursday. This means that Broadcom is already more than halfway through its fiscal 2023.
So if I say that Broadcom is likely to report around $18 billion of free cash flow in fiscal 2023, this perspective doesn't do this investment thesis justice.
In fact, I believe that it's very likely that looking out to fiscal 2024, Broadcom is priced at around 16x next year's free cash flows. For a business that's extremely well positioned and likely to benefit from an unexpected jump in demand, I believe that paying around 16x next year's free cash flows is a very enticing multiple.
The Bottom Line
In a nutshell, this is what I'm interested in investing in. Enabling the future. I believe that derivative AI opportunities are the best way to invest. Particularly in companies that, for now, haven't yet benefitted significantly from the AI hype.
Broadcom Inc. is a leading provider of custom AI computing switches. And compared with the rest of its semiconductor peers, its stock is not expensive at all. In sum, I make the case that paying 16x next year's free cash flow for Broadcom Inc. stock is mighty compelling.
For further details see:
Broadcom Q2 Earnings Preview: Why I Bought This Stock