Analysis

Up 55% So Far This Year, Is It Too Late to Buy Broadcom Stock?

Broadcom and Nvidia have emerged as the two secular growth leaders of the AI industry.

It may not quite be Nvidia, but top chip designer and infrastructure software provider Broadcom (AVGO -4.38%) has been on an epic run of its own. Broadcom stock is up just over 60% so far in 2024 — upstaged just a little by Nvidia’s more than 170% increase. What a year when being up “only” 60% doesn’t set any best-of records!

In tandem with its last earnings update, Broadcom also announced a 10-for-1 stock split that will occur in July 2024. Stock price aside (a split doesn’t change the fundamental value of shares), Broadcom has put together a unique business that may have lots more to give its shareholders over the next few years. Here’s why it may not be too late to buy, but also reasons to be cautiously optimistic.

Built by acquisition, unlike any other chip company

Broadcom, under the guidance of CEO Hock Tan, has built itself into a giant via many acquisitions. As the company Avago (headquartered in Singapore), Tan orchestrated the purchase of Broadcom in 2016 (Avago subsequently took the name of the acquired), and a couple of years later redomiciled the corporate headquarters to the U.S.

After a long string of chip design acquisitions, starting especially in 2017, Tan and company turned its attention to acquiring enterprise software businesses. This culminated in the purchase of top cloud management software provider VMware in 2023.

The takeaway here is that Broadcom’s exceptional run at purchasing many chip technologies and managing them exceptionally well (especially in terms of profitability) has put Broadcom in a pivotal position to benefit from the artificial intelligence (AI) infrastructure boom. Nvidia has of course pioneered and dominated the brand-new AI training data center market. But as big data center operators begin to grapple with the challenge of using that AI on a daily basis in their existing data centers, many of them have turned to Broadcom’s efficient chip design know-how and enterprise software.

In its most recent quarter (Q2 fiscal 2024, the three-month period ended on May 5), Broadcom reported 6% year-over-year growth in semiconductor sales. That may not sound like much, but much of the semiconductor industry, excluding artificial intelligence (AI) infrastructure remains in a deep downturn. Broadcom’s growth during this period thus implies it is picking up lots of market share. Tan said AI-specific chip sales were up 280% year over year last quarter.

A mega-acquisition with plenty of question marks

Besides all the AI chip hoopla, VMware is also being mixed into Broadcom’s software segment — which now makes up about 40% of total revenue. VMware was a critical cloud software provider enabling data center compute power to be split and partitioned out to companies wanting to “rent” compute power, but it was a lackluster software investment. Tan and company are trying to quickly change that, primarily by shuffling around its VMware partner program (consultants and such that resell VMware products to actual end customers).

As it has done with past software purchases, Broadcom is focusing on its biggest, most profitable VMware relationships. Tan said on the last earnings call that the old partner program threw VMware into “chaos,” so fixing the issues (read: making VMware dramatically more profitable) is just as messy an endeavor.

The good news is that VMware is indeed starting to get more profitable, even if actual VMware-specific revenue growth beyond this year may not be much of a factor. Nevertheless, total Broadcom adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) was 61% last quarter. Once integration expenses are mostly complete next year, VMware could help Broadcom’s free cash flow margins get close to 50% like they were last year (an incredible 49% free cash flow margin was the total for 2023, versus 36% this last quarter).

Even after its incredible rise, Broadcom trades for a reasonable-looking 44 times trailing-12-month free cash flow. It’s a premium price tag, but one that could moderate considerably if the company keeps notching AI semiconductor growth and unlocking cash from its big software segment.

Another reason to check runaway optimism is the big debt load Broadcom took on to acquire VMware. Total debt now stands at $74 billion, though management says it plans to keep paying this down at a rate of roughly $2 billion a quarter.

I’m a happy shareholder, and believe the good times will keep rolling for Broadcom this year. Keep an eye on progress with VMware and the related burden of debt as 2024 progresses.

Nicholas Rossolillo and his clients have positions in Broadcom and Nvidia. The Motley Fool has positions in and recommends Nvidia. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.

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