Broadcom (NASDAQ:AVGO) has many long-term catalysts. The stock’s low valuation and excellent long-term growth should outperform the S&P 500 over the next few years. Broadcom is trading below its industry and the market due to unpriced catalysts.
Broadcom makes semiconductors for many uses. The company focuses on digital and mixed-signal CMO devices and analog products. Broadcom’s products are used in set-top boxes, 5G, smartphones, Wi-Fi, Bluetooth, GPS, digital subscriber lines, passive optical networking central office SoCs, ethernet switching, routing, satellite system SoCs, custom touch controllers, enterprise and data center networking, broadband access, data center servers & storage systems, and more.
CHIPS and Science Act
The CHIPS and Science Act aims to boost U.S. semiconductor design, research, and manufacture. This law allocates $280 billion to lessen reliance on Taiwan and China for semiconductors. CHIPS and Science Act aims to improve the supply chain and retain U.S. economic and technical dominance.
The measure will help the semiconductor industry. U.S. semiconductor capacity has dropped from 25% in 1990 to 12% today. East Asia makes 75% of the world’s semiconductors. This new law encourages U.S. chipmakers to expand. The law can offset expansion and R&D construction and investment expenditures.
CHIPS and Science Act benefits Broadcom. Over the past year, the company spent $4.8 billion on R&D. The new law can provide additional R&D funding, providing the corporation more for its money. Broadcom’s R&D spending accounts for nearly 16% of its entire revenue. Therefore the law’s funds can enhance profitability.
CHIPS would also provide Broadcom with more funding to expand existing facilities and invest in new ones. This can help the company meet demand. In solving the chip shortfall, the entire semiconductor sector must raise production.
Broadcom’s stock rose 10% after the CHIPS and Science Act was unveiled, although Broadcom wasn’t completely priced in. The Inflation Reduction Act overshadows it. Enphase Energy (NASDAQ:ENPH) doubled when the Inflation Reduction Act was discussed. The CHIPS and Science Act wasn’t as well-publicized as the Inflation Reduction Act. Once Broadcom realizes the benefits of the new law, I think its stock will move.
Broadcom to Acquire VMware
Broadcom said in May 2022 that it would buy VMware for $61 billion in cash and stock. VMware is a leading software vendor for apps, cloud management/infrastructure, data center infrastructure, networking, and storage. VMware will contribute $13 billion to Broadcom’s annual revenue if the purchase goes through. VMware would boost Broadcom’s yearly net income and operating cash flow by $1.6 billion and $4 billion, respectively.
VMware can help Broadcom’s business. The chip business has sharper positive and negative market conditions than the larger market, which causes price swings. VMWare dominated the virtualization infrastructure software market in 2021. VMware held 72% of the market in 2021 and made $5.9 billion. VMware’s software business can counteract chip-based slowness.
The acquisition could boost Broadcom’s profit margins. VMware’s gross margin is 82% versus Broadcom’s 75%. VMware is software-based and boasts strong profit margins, while Broadcom’s revenue comes from its lower-margin hardware sector.
M&A arbitrage benefits VMware shareholders until the deal closes. Shareholders approved the agreement but need regulatory permission and won’t finalize until 2023. Takeover stock is $138. The price is now $121.58. If the merger closes, VMware stockholders could profit.
Market Growth
Broadcom serves growing markets. These markets can give Broadcom long-term growth. Even without the CHIPS and Science Act and VMware acquisition, these growing industries can help Broadcom.
Broadcom’s 5G market is growing. The 5G market might reach $248 billion by 2028, growing 72% annually. This includes smart manufacturing, connected vehicles, connected energy/utilities, smart cities, IoT, wireless broadband, cloud solutions, etc.
Broadcom also supports the developing global PON market. This market might reach $115 billion by 2028, growing 21% yearly. PON employs optical fiber to give infinite bandwidth. This allows service firms to communicate voice, video, and data over a network using personal credentials. Multiple consumers can share a PON connection without active components.
The global data center infrastructure management market could reach $3.1 billion by 2028, growing 11% annually. Internet users, cloud computing, and government initiatives drive this business.
The ethernet switches market might reach $96 billion by 2028, growing 9% yearly. Global pathology departments employ this imaging technology.
The global internet services market could reach $707 billion by 2028, up 9% yearly. This growth is driven by advancing technology, government initiatives, increased device use (smartphones, tablets, etc.), and growing internet services.
I could list every market Broadcom service, but I chose the biggest. Broadcom’s other growing markets can boost its growth. Many markets cooperate, of course.
Broadcom provides semiconductor solutions for growing technologies. These developing markets should boost Broadcom’s long-term growth.
Broadcom Stock Is Cheap
Broadcom’s PEG ratio is 19% below the Semiconductor industry. Broadcom trades at a 14.8 forward P/E and 0.90 PEG. The semiconductor industry’s P/E is 16, and PEG is 1.11.
Broadcom’s forward P/E of 18.9 and PEG of 1.54 are below the S&P 500’s. Broadcom is a strong value in its industry and the market. Potential catalysts aren’t fully priced in.
Over the next 3 to 5 years, Broadcom’s earnings are expected to climb 16% annually. VMware expects 19% annual revenue growth during the same time. Broadcom’s stock might outperform the S&P 500 with a lower valuation and more robust growth. In the next 3 to 5 years, the S&P 500 is predicted to boost earnings by 12% annually.
Balance Sheet
Broadcom has $9b in cash and $39b in debt. Despite the high debt, the balance sheet and cash flow are robust. The company’s $21 billion in stockholders’ equity is 2.1x current assets and 1.4x total assets.
Broadcom’s operating cash flow was $14.8 billion in the past year. After dividends, repurchases, debt repayment, CapEx, etc., Broadcom had $12 billion in levered free cash flow.
The significant debt looks worrying, but it shouldn’t be a problem if the business keeps growing. Broadcom’s solid cash flow will help reduce debt.
Broadcom would add $13 billion in total debt or $9 billion in net debt if the VMware deal is complete. VMware’s balance sheet is weaker than Broadcom’s. VMware’s current assets are 1.34x its current liabilities, while its total liabilities exceed total assets by $411 million. VMware’s balance sheet inadequacies won’t hurt the merged firm since both are profitable and growing with positive cash flow.
Dangers
Broadcom’s risk is the cyclical semiconductor market. Semiconductor downturns are more common than marketwide. The stock can undergo more frequent drops than the S&P 500.
Regulators may not approve VMware’s acquisition. It’s unlikely yet possible. Broadcom may sell off if the deal isn’t authorized.
Supply chain bottlenecks are another risk. It could hurt sales if the company didn’t get enough raw materials.
Broadcom’s Future
Broadcom will profit from the CHIPS and Science Act and expansion in its markets. The VMware acquisition would boost Broadcom’s future.
Broadcom’s inexpensive value allows space for upside as it grows earnings at an above-average pace over the next 3 to 5 years. As the Fed continues to raise interest rates to control inflation, the broader market appears shaky over the next 6 to 12 months. So, investors shouldn’t buy the stock now. Wait for another market slump or selloff with patience.
Broadcom should beat the S&P 500 over the next 3 to 5 years due to its above-average growth and below-market valuation. Broadcom trades below the industry and the broader market; therefore, its growth catalysts are undervalued.
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