Broadcom (AVGO) has witnessed a remarkable rally, surging by over 50% since early December 2023, significantly outperforming the broader U.S. market. As the company approaches another earnings release, slated for March 7, it’s prudent to revisit its investment thesis and preview the upcoming results. Despite a robust previous quarter and consensus projections of substantial revenue growth, concerns linger around the expected flat bottom line. However, historical correlations between revenue growth and profitability expansion, coupled with promising developments in the AI industry, suggest reasons for optimism. This article provides an update on AVGO’s recent performance, previews the upcoming earnings release, and evaluates its valuation.
Recent Developments and Earnings Preview: AVGO’s previous earnings release showcased a slight beat on consensus estimates, accompanied by a notable guidance boost during the FQ4 2023 earnings call. The company reported a 4% year-over-year revenue growth and an expanded adjusted EPS. Notably, the improvement in operating margins signals a bullish stance from management towards operational excellence. Additionally, aggressive deleveraging efforts resulted in a strengthened balance sheet, with $14 billion in cash reserves. Looking ahead, consensus estimates project a massive 31% year-over-year revenue growth for Q1, with a conservative outlook on adjusted EPS. However, the management’s optimistic stance on future prospects, coupled with a flawless earnings surprise history, suggests the potential for an earnings beat.
Portfolio Refinement and AI Trends: AVGO continues to refine its portfolio through strategic divestments, with the recent End-User Computing Division divestment valued at approximately $4 billion. While such divestments may not significantly impact earnings or valuation, they streamline corporate structure and enhance operational efficiency. Furthermore, the company remains focused on innovation, particularly in 5G and Edge Computing, aligning with the burgeoning demand for AI hardware. The AI servers market’s projected 50% compound annual growth rate over the next three years underscores the significance of AVGO’s position in capturing this demand.
Valuation Update: Despite AVGO’s stock trading at an all-time high, its valuation remains attractive. While traditional valuation ratios indicate high levels, a discounted cash flow (DCF) approach suggests undervaluation. Adjusting the weighted average cost of capital (WACC) to 9.25% and refining free cash flow margin assumptions, the DCF model indicates a fair value slightly above the current market cap. Moreover, an optimistic scenario with an aggressive revenue growth trajectory propels the fair value significantly higher, reflecting the potential for substantial upside.
Risks to Consider: Amidst the optimism, it’s crucial to acknowledge risks, particularly regarding revenue growth forecasts. Any downgrade in long-term revenue projections could adversely impact the stock’s fair price. Additionally, regulatory scrutiny over potential acquisitions poses a risk, potentially limiting AVGO’s ability to sustain its stellar revenue growth trajectory.
Conclusion: In conclusion, Broadcom (AVGO) remains a compelling “Strong Buy” ahead of the upcoming earnings release. Positioned to capitalize on surging demand for advanced hardware in AI-driven applications, the company’s attractive valuation and potential for earnings beat underscore its investment appeal. While regulatory hurdles and conservative EPS estimates pose risks, AVGO’s strong fundamentals and strategic initiatives bode well for sustained growth and shareholder value creation.
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