Broadcom Stock: Custom Computing Chips and Generative AI SaaS Demand Are Real (NASDAQ:AVGO)

AVGO’s high-growth investment thesis remains cheap

We previously covered Broadcom (NASDAQ:AVGO) in February 2024, discussing why we reiterated our Buy rating due to the accelerated profitable growth reported in FQ1’24 and the AI Sales Guidance in FY 2024.

Coupled with excellent shareholder returns and robust generative AI trends from infrastructure to SaaS, we thought every moderate pullback was a mid-dollar opportunity.

AVGO YTD share price

Since then, AVGO has traded mostly sideways at +4.8%, similar to the broader market at +2.3%, as the market pivoted away from high-growth stocks to mid-July 2024, the same pattern also seen in numerous semiconductor stocks and ETFs.

Some of the headwinds can be attributed to tougher year-over-year comparisons, at +122% reported by the semiconductor king stocks, Nvidia (NVDA) in the recent FQ2’25 earnings call compared to a year ago at +101% in FQ2’24 and the previous quarter at +262% in FQ1’25.

While demand for AI accelerators remains robust, as guided by Jensen Huang for Q3’25 with revenue growth expected to be +79.3% YoY, it is clear that triple-digit YoY growth is not sustainable, as discussed in our previous NVDA article here.

These developments matter because AVGO previously guided FY2024 AI-related revenue of more than $10 billion (+66.6% YoY), comprising more than 20% of total forecast revenue.

For now, its outlook appears robust, with management already raising its FY2024 AI revenue guidance to around $12B (+100% YoY) in the recent FQ3’24 earnings call, implying minimal upside headwinds, while significant. helped by the very heavy acquisition of VMware.

This is also why AVGO raised its FY2024 overall revenue guidance to $51.5 billion (+5.1% pro forma y/y/+43.8% y/y) with improved adjusted EBITDA margins of 61.5% (-3.3 points per year).

This compares to the initial guidance of $50bn (+2% YoY post forma/ +39.6% YoY) and 60% (-4.8pts YoY) provided in the FQ4’23 earnings call.

Much of AVGO’s tailwinds are attributed to growing demand for custom application-specific integrated circuits (ASICs) from global hyperscalars, which have “created as much of their own computing silicon as possible.”

Readers should note that hyperscalers have accelerated the “deployment of their GPUs, next-generation XPU ASICs and connectivity in their data centers here in the second half of the year,” with another benefit already visible by 2025.

While hyperscalers placed orders for NVDA’s next-generation GPUs, as seen with Alphabet ( GOOG ) at $10 billion, Meta ( META ) at $10 billion, and Microsoft ( MSFT ) at $1.62 billion , Amazon ( AMZN ) also opting to trade Grace Hopper Orders for Blackwell, AVGO has already highlighted the huge opportunity in the custom AI accelerator market, which has grown 3.5x per year.

Combined with the fact that ASICs comprise 70% of AVGO’s AI-related revenue, we’re really not surprised by these highly promising developments, with the semiconductor company’s well-diversified capabilities in software and hardware coming into play here.

In any case, AVGO’s high-margin subscriptions/services segment continues to demonstrate robust top-line growth to $5.63 billion (+6.4% q/q. non-comparable) with gross margins increasingly richer by 87.5% (+1 point q/q/+3.3 yr). .

Robust enterprise demand was also seen in multi-year performance obligations remaining relatively flat at $21.2 billion (-7.4% ToT/ inline YoY) and VMware Cloud Foundation booking growth of 2.5 USD billion in FQ3’24 (+32% QoQ) – as reported by management:

The VMware business continues to book very well because we’re converting our customers a lot in two ways, one, from a perpetual license to a subscription license, but also those subscription licenses for the full VCF stack. And that was very successful, as I indicated, given the high ratio of VCF subscribers, new subscribers we got.

And we see that trend continuing into Q4 very much and also very likely into ’25. So in terms of the directional trend, other than the indication that I’m giving you — than the guidance that I’m giving you in Q4 ’24, directionally, we continue to see accelerated bookings and by extension, accelerated growth. (Looking for Alpha)

Advance consensus estimates

Following robust development around its ASIC and SaaS prospects, it is no surprise that the consensus has already raised its forward estimates, with AVGO expected to generate accelerated top/bottom-line growth at a CAGR of +23.6%/ +19.8% by fiscal year 2026.

This compares to previous consensus estimates at a CAGR of +5.2%/ +7.8% and historical growth at a CAGR of +15.2%/+15.7% between FY2016 and FY2023, respectively.

AVGO ratings

And it is for these reasons that we believe AVGO is not expensive at FWD non-GAAP P/E valuations of 30.57x, up from its 1Y average of 25.09x and 5Y average of 18.40x.

This is attributed to the relatively reasonable non-GAAP FWD PEG ratio of 1.16x, based on its projected EPS adj expansion from LTM adj EPS of $4.55 ending FQ3’24 and consensus estimates for FY2026 Adj EPS of $7.26 on a CAGR of $7.26. +26.3%.

Even compared to the sector median of 1.78x and peers such as NVDA at 1.04x, TSM at 0.93x, AMD at 0.98x, INTC at 1.83x and ASML at 1.63x, we believe that AVGO continues to trade reasonably, giving interested investors an improved margin of safety after the sharp pullback from the June 2024 peak.

So, AVGO Stock is a Buysell or keep?

AVGO 4Y Share Price

For now, after the exuberance of the stock split has moderated and the market rotation is well behind us, it is clear that AVGO remains well supported on the upper floor at $140, already on track to retest the intermediate resistance levels of $160 . at the time of writing.

For context, we provided a fair value estimate of $120 (post 10 for 1 stock split) in our last article, based on adj LTM EPS of $4.29 and forward FWD P/E valuations of 28.11x.

Based on $4.55 adj LTM EPS ending FQ3’24 and updated non-GAAP FWD P/E valuations of 30.57x, we’re looking at an updated fair value estimate of $139.10 – with this close of AVGO’s recently established support levels of $140. s.

Based on the revised FY2026 consensus adjusted EPS estimates of $6.54 to $7.26, we are also looking at an updated long-term price target of $221.90, implying excellent upside potential of + 40.2% from current levels.

Finally, readers can look forward to another dividend increase until the end of 2024, according to AVGO’s historical trends. Based on the latest growth of +14.1% and the 5-year dividend growth rate of +15.9%, we may be looking at an annualized payout of approximately $2.42 per share (+14%).

While forward dividend yields of 1.5% may seem disappointing compared to its 4-year average yields of 2.55% and US Treasury yields between 3.46% and 4.99%, investors can take consider subscribing to a DRIP program, allowing them to regularly accumulate additional shares quarterly.

Due to the very attractive risk/reward ratio, we reiterate our Buy rating on AVGO shares.

Risk warning

Thanks to the VMWare acquisition, AVGO’s long-term debt rose dramatically to $69.95 billion last quarter (-5.4% QoT/ +77.8% YoY), triggering an annual interest expense increase of 4.24 billion USD (+1.9% QoT/ +165% YoY).

While the semiconductor company continues to generate rich free cash flow of $18.65 billion over LTM (+7.3% sequentially), its path to deleveraging may be prolonged, attributed to $9.23 billion in dividend obligations (+24% YoY) and the laser focus of management. on returning high value to shareholders over the long term.

As a result, readers may want to temper their near-term expectations, with AVGO’s bottom line performance likely to suffer before its balance sheet health improves.

At the same time, with the stock market in fear territory, there may be near-term volatility, with us cautioning interested investors to wait for a moderate pullback before adding based on risk appetite and dollar cost averages.

Patience may be more prudent for now.