Broadcom: Still One Of The Best Tech Income Stocks (NASDAQ:AVGO)

Article Thesis

Broadcom (NASDAQ:AVGO) is a fast-growing semiconductor company with attractive shareholder payouts. Today, shares offer an above-average dividend yield of 3.2% and trade at a very reasonable valuation of just 14x forward net profit. While Broadcom will not be immune to a recession, its business isn’t overly cyclical and the inexpensive valuation offers a margin of safety.

Broadcom: Positive Growth Outlook

Many tech investors put a lot of value on a stock’s earnings growth rate, which makes sense, as the tech industry is growing faster than the overall economy. As a result, growth-heavy companies are overrepresented in the tech space, relative to slower-growth industries such as automobiles, consumer staples, and so on.

Broadcom has generated very compelling growth in the past, and I believe that the company is well-positioned for ongoing business and earnings per share growth in the future, too.

With its portfolio, Broadcom is highly exposed to a range of fast-growing markets with significant long-term potential:

In its network segment, for example, Broadcom is exposed to markets such as hyperscale data centers. Hyperscale data centers are run by companies such as Microsoft (MSFT) and Amazon (AMZN) for their respective cloud computing offerings, for example. Cloud computing is an absolute growth market that will continue to expand for many years, which means that the market opportunity for Broadcom will continue to expand as well. In its server & storage connectivity business, Broadcom will also benefit from the growing hyperscale data center market. Emerging trends, such as artificial intelligence, augmented and virtual reality, autonomous vehicles, and so on will require massive computing power that will often come in the form of huge data centers, thus growth drivers for this important market for Broadcom will not cease to exist anytime soon.

Broadcom’s industrial business will continue to grow as well. Green electricity requires smart grids as many different electricity producers are adding power to the grid at different times (depending on weather conditions for wind and solar), while new power consumers are also added, such as electric vehicle charging points. This requires significant upgrades for existing grid infrastructure, and Broadcom will be one of the companies benefitting from that theme. In manufacturing, robots and other automation tools are driving efficiency and help combat labor shortages, which is why the use of robots will most likely continue to rise in the long run. Those robots need to be connected to each other in order to communicate, and they need to have sensors that allow them to operate efficiently and safely. Last but not least, connectivity and sensing systems also become ever more important in the automobile space, where driver assist systems and autonomous driving technology require many more sensors and chips compared to what vehicles used to require a decade or two ago.

Broadcom is still generating the majority of its revenue from its hardware business, but its software business has been growing fast, thanks to acquisitions that Broadcom has made in this space. In the software space, AVGO is also well-positioned to benefit from market growth in the future. Cybersecurity offerings such as the ones Broadcom sells are important and will likely become even more important — and thus in demand — in the future, as businesses, consumers, and even governments and state actors want to harden their products and infrastructure against criminal activity, terrorism, and so on.

All in all, there are good reasons to assume that Broadcom will continue to deliver solid business growth in the long run, even when we back out potential M&A. But since Broadcom has a history of adding inorganic growth to its already existing organic growth, it would not be surprising to see Broadcom make takeovers from time to time in the future, too. The bad news here is that those takeovers will likely not be as transforming as they were in the past, due to two reasons:

– First, Broadcom’s balance sheet already employs considerable leverage. The company is not overleveraged, but it will not be able to add more debt endlessly, especially since rising interest rates will make its debt more costly in the future. Broadcom currently has a $27 billion net debt position according to its most recent 10-K filing, which is equal to around 1.6x this year’s expected net profit. There is thus some capacity for additional debt, but Broadcom will likely not be able to add dozens of billions in debt, thereby limiting its potential for inorganic growth to some degree.

– Second, Broadcom has become a pretty large company. It generated revenue of $33 billion over the last year, which is up by an incredible 1,300% over the last decade. Adding $1 billion in additional revenue via M&A is much less of a game-changer today, relative to five or ten years ago.

Due to these reasons, I believe that Broadcom’s inorganic growth will be less pronounced going forward, although I still expect AVGO to make minor acquisitions here and there. Broadcom will thus surely not deliver another 1,000%+ of revenue growth over the next decade, but the good thing is that this isn’t needed. Even a 5% revenue growth rate could be more than enough for solid total returns going forward (more on that later), and I believe that this will not be a significant hurdle for the company going forward.

More Resilient Than Many Other Chip Stocks

Broadcom’s semiconductors aren’t very commoditized, unlike, for example, the products made and sold by Micron (MU). That is why I expect that Broadcom will outperform many other chip companies in a recession or economic downturn. We have already seen Micron, Intel (INTC), NVIDIA (NVDA), and other chip companies experience considerable slowdowns in recent quarters, while Broadcom continued to deliver compelling results: In its most recent quarter (results were announced in December), the company grew its revenue by an attractive 21% year over year, beating estimates. AVGO’s guidance for the first quarter, the one we are in right now, implies revenue growth of 16% year over year, which was ahead of estimates as well, and which implies that Broadcom is not feeling a considerable slowdown thanks to its diversified and non-commoditized product portfolio.

Still A Strong Income Investment

Unlike many other tech companies, Broadcom offers an above-average dividend yield and puts a lot of value on its dividend growth track record. At current prices, investors get a 3.2% dividend yield, which is close to twice as much as what one can get from the broad market today (1.7%):

Over the last five years, Broadcom has grown its dividend at an impressive rate of 29%, and the annual dividend increases data back 11 years. Of course, it is a mathematical certainty that Broadcom will not grow its dividend at a 20%-30% annual pace forever. But even if dividend growth will be way lower going forward, Broadcom could still deliver attractive returns.

As noted earlier, 5% annual revenue growth seems like a slightly conservative base case assumption. When we add some tailwinds from buybacks, Broadcom could easily deliver earnings-per-share growth in the 7%-10% range over the coming years, I believe. Dividend growth of ~10% per year thus seems achievable for the coming years, as the payout ratio of 45% also leaves some room for growth. When a company offers a dividend that yields 3.2% and that can realistically grow by 10% per year for the foreseeable future, that makes for an attractive dividend growth investment — although future returns will still be lower compared to what investors experienced over the last decade.

Today, Broadcom trades at 14x forward net profits. That is a pretty inexpensive valuation compared to most chip stocks, and also relative to the broad market. When we compare the current valuation to Broadcom’s historical valuation, we see the following:

Note: I use EV/EBITDA as this accounts for changes in debt usage.

Broadcom currently trades at a 24% discount compared to its 5-year median valuation, which implies that right now could be a better-than-average time to enter or expand a position. Of course, Broadcom’s larger size makes it likely that future growth will be somewhat less pronounced, which could justify a discount versus the historical valuation norm. But even then, the current 12x EBITDA multiple seems far from high, and Broadcom looks moderately undervalued — multiple expansion towards a 13-15x EBITDA valuation does not seem unrealistic to me.

Takeaway

Broadcom’s business grew more than 10x over the last decade — that will not happen again. But thanks to exposure to growth markets and some M&A potential, Broadcom should still offer solid revenue and earnings growth going forward, which will allow Broadcom to continue to grow its dividend as well.

Shares have risen considerably from last year’s lows, but at just 14x net profits, they are far from expensive. The current valuation discount versus the historical valuation norm also suggests that Broadcom is trading below fair value today. We last covered Broadcom last August when we called it one of several attractive income stocks — since then, AVGO has beaten the market by 10%, and it remains attractive today.