Summary
- Broadcom has been a Dividend Growth Darling due to its outstanding 39% CAGR over the last decade.
- Although forward growth will be significantly lower, the company still has room to grow its dividend.
- The uncertainties around the VMware merger and the ever-present Apple risk keep looming over the stock.
- Broadcom still presents a good Dividend Growth opportunity, but investors need to expect lower growth going forward.
Dividend Growth Investing (often abbreviated as DGI) has been a very popular strategy among investors in recent years due to its potential to generate stable and growing income streams over the long term. Especially over the last years, with interest rates at historically low levels, investors were and are looking for stocks that can continuously raise their dividends rapidly. The true power of DGI is shown once dividends are reinvested into the company, creating a snowball effect by compounding the quarterly dividends received over the years. One of the best DGI stocks of the last decade has been Broadcom (AVGO), a leading semiconductor and software company.
In the picture below, Broadcom grew its dividend frantically over the last decade. From $0.67 in 2013 to $16.9 in the trailing twelve months, an astounding 25-fold increase translates to a median growth rate of 40%. This track record is unmatched and grew the company to one of the largest semiconductor stocks on the planet at an enterprise value of $272 billion. The only larger semis are Taiwan Semiconductor (TSM) at over $400 billion and Nvidia (NVDA) at over $470 billion. Let's see what kind of Dividend growth we could see from Broadcom in the future.
Broadcom Dividend growth history (Koyfin)
Seeking Alpha Dividend Grades
As shown in the picture below, Broadcom scores very well in all areas according to Seeking Alpha's Dividend Grades. The company recently raised its dividend by 12% and has been growing it for eleven years. The dividend is also safe at a 41% Free cash flow payout ratio over the last year.
Broadcom Dividend grades (Seeking Alpha Premium)
The 5-year growth rate of 28.57% is hardly realistic to expect going forward; let's do some back-of-the-envelope math to see what the next five years of dividend growth could look like.
Growth by acquisition
Broadcom has run a strategy that relied a lot on growth by acquisition and radical cost discipline over the last decade; I talked more about the overall strategy in my previous AVGO article . This has catapulted Broadcom from just $8 billion enterprise value in 2013 to the $270 billion they are worth now.
Broadcom past growth history (Koyfin)
As the law of large numbers continues, AVGO is forced to make ever-larger acquisitions to keep up. This is not sustainable at their size and I hope no investor expects them to continue their 28% dividend CAGR. Their most recent deal is their largest so far: $61 billion (plus $8 billion in debt taken over) for VMware (VMW). This deal is facing antitrust investigations and skepticism by analysts. Some analysts expect Broadcom to continue its strategy of milking acquired software companies by cutting R&D budgets and rationalizing the business. This approach should certainly push profit margins higher, with Broadcom's ambitions to double EBITDA ( Slide 13 ). The company expects $ 8.5 billion in EBITDA as a target, but I do not understand how they get to $4.7 billion of FY 22 EBITDA for VMware. According to Koyfin, Seeking Alpha and Macrotrends, EBITDA should have been around $3 billion for FY 22. In FY 22, VMware spent $4 billion on S&M, $3 billion in R&D and $1 billion in G&A, so Broadcom would have to rationalize most of those budgets to reach its goal.
The looming Apple threat
Another threat looming above Broadcom's head is that Apple (AAPL) could cut off Broadcom in the future and use its own chips. I do not think this will happen anytime soon, but it's a risk to consider, as Apple accounts for around 20% of Broadcom's revenue. Fellow contributor Joe Albano wrote a great article about the Apple situation here . For the sake of the following model, let's assume that Broadcom could lose 85% of its Apple revenue (17% of revenues), as Joe mentioned as the worst case.
Broadcom's earnings potential going forward
Let's see what both of these factors could mean for the near future of Broadcom. At its current $33 billion in revenue, Apple should account for roughly $6.6 billion in revenue, or $5.775 billion at risk, assuming that Broadcom can retain 15% of it. According to the Merger presentation, VMware would immediately add around $12 billion in sales and $3 billion in EBITDA to the company, with the potential of $8.5 billion in EBITDA. This means Broadcom's revenues should be somewhere between $27.23 (worst case) and $45 billion (best case). For EBITDA, that would get us between $15.8 and $27.8 billion and if we use an 85% FCF conversion, we will get between $13.4 and $23.6 billion in Free cash flow. No matter which case, it leaves significant space for dividend hikes from the current $6.73 billion payout. Another part to consider is the debt AVGO has. If the merger goes through, the company would add $32 billion in new debt plus $8 billion of debt assumed from VMware, ending at a $67 billion net debt position. This would leave them with manageable leverage between 2-3 times EBITDA and Broadcom has a history of successfully delevering after their prior large acquisitions. According to Gurufocus , AVGO's effective interest rate on its debt is 4.11%. Even if we'd assume a 5% interest rate, the annual interest payments would be just $3.3 billion versus, worst case, $13.4 billion in FCF.
Post-acquisition delevering (AVGO VMW merger presentation)
Conclusion
According to Seeking Alpha , analysts expect Broadcom to grow its earnings around mid to high single digits and I believe that is a very reasonable assumption. The large earnings power, a low payout ratio, and modest growth going forward should allow AVGO to continue raising its dividend alongside earnings in the high single digits to low teens. There are still uncertainties around regarding the merger; even though unlikely, the Apple risk is still looming. As a solid dividend growth stock with ample opportunity to raise its dividend, I'd consider Broadcom a light buy.
For further details see:
Broadcom: This Dividend Growth Darling Is Likely To Keep Up The Pace