Summary
- Broadcom shares have followed the semiconductor sector down this year, as fears grow around shrinking lead-times and shrinking sales in 2023.
- Broadcom isn't immune to slowdowns, particularly in consumer-facing segments like smartphones and broadband, but 2023 should still be a strong year for high-end data center demand.
- Cyclical downturns are a good opportunity to pick up shares of great companies at more reasonable valuations; there is still some risk from here, but the long-term valuation is attractive.
It’s tough to own a nice house in a declining neighborhood, and I think that’s largely the reason that Broadcom ( AVGO ) shares are down another 20% since my last update . While Broadcom has continued to outperform the broader sector (as reflected through the SOX), investors are finally waking up to the reality that the semiconductor industry is still cyclical and that 2023 is likely to see slowdowns in many sub-sectors.
I do see areas of concern for Broadcom over the next 12 months, but I think the underperformance is likely overstated given the company’s strong leverage to advanced data center and cloud spending, as well as the more stable enterprise software operations. Valuations across the sector got overheated on the way up though, so there is a reckoning process here for sentiment that Broadcom cannot escape. Even so, mid-to-high single-digit long-term revenue and FCF growth now support a double-digit annualized potential return, making this a name to consider as a buy-the-dip.
“It’s On Fire! Whole Thing’s On Fire!”
Worries about the semiconductor industry in 2023 are likely to only intensify from here, particularly with Texas Instruments ( TXN ) and STMicro ( STM ) spooking the Street with their guidance for the fourth quarter (even though weaker Q4 guides are not unusual for TI, as I discussed recently ). Consumer end-markets are contracting, industrial demand is slowing noticeably, and there are growing worries about auto chip demand in 2023.
Thing is, that doesn’t matter too much for Broadcom. Industrial and auto exposure here is small, and while the company is vulnerable to weaker trends for this latest generation of Apple ’s ( AAPL ) iPhone, there is still some content growth to boost results and it’s not a crippling part of the business (around 15%). Likewise with broadband – MaxLinear ’s ( MXL ) recent report does suggest weakening trends in home broadband, but Broadcom should benefit from its leverage to the Wi-Fi 6/6E cycle. All told, only around a quarter to a third of Broadcom’s revenue by end-market looks meaningfully at risk over the next 12 months – not trivial, but not a crisis either.
On the flip side, while data center capex is likely to moderate overall next year (and this is a headline/sentiment risk for Broadcom), I think the details matter. First, I would still expect high single-digit to low double-digit overall spending growth next year ( Meta ( META ) just guided for 12% growth), and that’s not bad. More significant, though, is WHERE that spending goes, and this is where I think Broadcom can surprise.
I expect a meaningful 200G/400G upgrade cycle next year for high-end data center customers, and that will support strong demand for Broadcom’s leading (and high-margin) Tomahawk and Jericho lines (as well as Marvell ’s (MRVL PAM4 DSP products). Likewise, I expect ongoing above-market growth for Broadcom’s custom data center ASICs for compute and storage, and I think the company will pick up more business from Meta and Microsoft ( MSFT ) over the next year.
Weaker Areas Should Be More Of A Blip
Going back to the areas of Broadcom’s business that may be weaker, I think even here this is more of a speed bump than a pothole (let alone a sinkhole).
Looking at the handset business, Broadcom management has talked about a two to three-year roadmap with Apple and the possibility of sustainable 5% to 10% annual content growth in areas like RF (more filtering for newer models), connectivity, and custom ASICs. While Qorvo ( QRVO ) and Skyworks ( SWKS ) have made some progress in RF, I don’t really see Broadcom as seriously threatened here, and I think the weaker near-term outlook for Apple’s newest phones is likely only a low single-digit risk to Broadcom’s top line.
In Broadband, management did guide to 20%-plus growth in this current quarter, and MaxLinear’s report suggests that could be a bit more challenging, with their Broadband segment (chips for set-top boxes) down 5% yoy (and 14% qoq). Connectivity (MoCA, home gateways, and Wi-Fi) was up 118% yoy and 46% qoq, though, and I think this will mitigate some of the risk to Broadcom’s results.
Longer term, I don’t think either business is in serious trouble. Smartphone growth will likely never be what it used to be, but it’s a profitable enough business for Broadcom. Broadband may see some moderation ahead of the next upgrade cycle, but I think the Wi-Fi 6/6E trend could still have legs.
Software Can Offer Stability
Broadband’s Infrastructure business (mostly enterprise software) is seen by some as a drag on the business, with management willing to accept weaker revenue growth (up 5% yoy in the last quarter versus 32% growth in Semiconductor revenue) in exchange for strong recurrent free cash flow. I think that “drag” may not look so bad if the semiconductor cycle surprises to the downside, as the strong subscription-based revenue will hold up better in a weaker economic environment.
The Outlook
Considering some moderation in data center spending in 2023, as well as weaker near-term trends in consumer-facing businesses (smartphones and broadband), I’ve trimmed my FY’23 revenue outlook slightly, but the impact is mitigated by a stronger-than-expected FY’22, so that revision comes from a higher starting point.
I’m still looking for Broadcom to generate around 8% revenue growth over the next five years and closer to 6% over the longer term, with the company’s very strong positions in switching / routing and custom silicon driving much of this (and storage/connectivity to a lesser extent). I also still expect strong margins over time, as Broadcom continues to maintain a large lead over its rivals in most of its most lucrative product lines, and uses that technological superiority to push for strong pricing. I think adjusted FCF margins can head into the high-40%’s over time, supporting long-term FCF growth in the neighborhood of 8%.
The Bottom Line
Discounted cash flow suggests a long-term total annualized potential return in the double digits, making this a name well worth consideration on this pullback. Multiples-based approaches grounded in margins also support the idea of a higher share price (above $600), but I will note that the market’s opinion of a “fair” forward multiple swings significantly between the boom and bust phases of the cycle. If the market goes back to the worst valuations in my database, Broadcom’s fair value would fall to about where it is today.
Investing in Broadcom is not without its risks, as the outlook for 2023 (and 2024) could certainly get worse from here and investors could once again return to panic-level valuations. I think that risk is fairly modest, though, and I think the longer-term opportunities with one of the best semiconductor companies in the business make it a risk worth taking.
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Sector Fears Shadowing Broadcom Despite A Differentiated Outlook